Growth, Debt, and Inequality

Abstract

After the 2009 global recession, many papers identified a non-linear inverted U-shaped relationship between economic growth and sovereign debt. However, their results are mixed regarding the exact turning point and, recently, the direction of its causality. According the traditional view, we assume debt-to-growth causality and show that the mixed results depend on the heterogeneity of the non-linear debt-growth relationship. In our sample of 27 countries over the period 1994-2010, countries with higher Gini index, our measure of income inequality, show lower threshold points upon which further increases in debt reduce growth but a higher sensitivity of growth to debt changes. Hence, the more distributionally fair countries are, the more fiscally virtuous they should be to growth. The policy implication is that more equal income distribution policies reduce (increase) economic growth in (not) highly indebted countries.

Keywords: sovereign debt, economic growth, income inequality, heterogeneity

JEL Classification: H61, H62, H63