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Financial Stress, Sovereign Debt and Economic Activity in Industrialized Countries: Evidence from Dynamic Threshold Regressions

  • Christian R. Proaño

    ()

    (Department of Economics, The New School for Social Research)

  • Christian Schoder

    ()

    (Department of Economics, Vienna University of Economics and Business)

  • Willi Semmler

    (Department of Economics, The New School for Social Research)

We analyze how the impact of a change in the sovereign debt-to-GDP ratio on economic growth depends on the level of debt, the stress level on the financial market and the membership in a monetary union. A dynamic growth model is put forward demonstrating that debt affects macroeconomic activity in a non-linear manner due to amplifications from the financial sector. Employing dynamic country-specific and dynamic panel threshold regression methods, we study the non-linear relation between the growth rate and the debt-to-GDP ratio using quarterly data for sixteen industrialized countries for the period 1981Q1-2013Q2. We find that the debt-to-GDP ratio has impaired economic growth primarily during times of high financial stress and only for countries of the European Monetary Union and not for the stand-alone countries in our sample. A high debt-to-GDP ratio by itself does not seem to necessarily negatively affect growth if financial markets are calm.

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Paper provided by Vienna University of Economics and Business, Department of Economics in its series Department of Economics Working Papers with number wuwp167.

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Date of creation: Feb 2014
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Handle: RePEc:wiw:wiwwuw:wuwp167
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