Debt and Growth: New Evidence for the Euro Area

22 Pages Posted: 27 Jul 2012

See all articles by Anja Baum

Anja Baum

University of Cambridge - Faculty of Economics and Politics

Cristina D. Checherita-Westphal

European Central Bank (ECB)

Philipp Rother

European Central Bank (ECB)

Date Written: June 28, 2012

Abstract

Against the background of the euro area sovereign debt crisis, our paper investigates the relationship between public debt and economic growth and adds to the existing literature in the following ways. First, we extend the threshold panel methodology by Hansen (1999) to a dynamic setting in order to analyse the nonlinear impact of public debt on GDP growth. Second, we focus on 12 euro area countries for the period 1990-2010, therefore adding to the current discussion on debt sustainability in the euro area. Our empirical results suggest that the shortrun impact of debt on GDP growth is positive and highly statistically significant, but decreases to around zero and loses significance beyond public debt-to-GDP ratios of around 67%. This result is robust throughout most of our specifications, in the dynamic and non-dynamic threshold models alike. For high debt-to-GDP ratios (above 95%), additional debt has a negative impact on economic activity. Furthermore, we can show that the long-term interest rate is subject to increased pressure when the public debt-to-GDP ratio is above 70%, broadly supporting the above findings.

Keywords: Public debt, economic growth, fiscal policy, threshold analysis

JEL Classification: H63, O40, E62, C20

Suggested Citation

Baum, Anja and Checherita-Westphal, Cristina D. and Rother, Philipp, Debt and Growth: New Evidence for the Euro Area (June 28, 2012). ECB Working Paper No. 1450. Available at SSRN: https://ssrn.com/abstract=2094998

Anja Baum (Contact Author)

University of Cambridge - Faculty of Economics and Politics ( email )

Austin Robinson Building
Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom

Cristina D. Checherita-Westphal

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Philipp Rother

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 0 (Phone)
+49 16 1344 6398 (Fax)

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