Is There a Debt-Threshold Effect on Output Growth?

54 Pages Posted: 8 Jul 2015

See all articles by Alexander Chudik

Alexander Chudik

Federal Reserve Banks - Federal Reserve Bank of Dallas

Kamiar Mohaddes

University of Cambridge - Faculty of Economics and Politics; University of Cambridge - Girton College

M. Hashem Pesaran

University of Southern California - Department of Economics; University of Cambridge - Trinity College (Cambridge)

Mehdi Raissi

International Monetary Fund (IMF) - Asia and Pacific Department

Multiple version iconThere are 4 versions of this paper

Date Written: July 3, 2015

Abstract

This paper studies the long-run impact of public debt expansion on economic growth and investigates whether the debt-growth relation varies with the level of indebtedness. Our contribution is both theoretical and empirical. On the theoretical side, we develop tests for threshold effects in the context of dynamic heterogeneous panel data models with cross-sectionally dependent errors and illustrate, by means of Monte Carlo experiments, that they perform well in small samples. On the empirical side, using data on a sample of 40 countries (grouped into advanced and developing) over the 1965-2010 period, we find no evidence for a universally applicable threshold effect in the relationship between public debt and economic growth, once we account for the impact of global factors and their spillover effects. Regardless of the threshold, however, we find significant negative long-run effects of public debt build-up on output growth. Provided that public debt is on a downward trajectory, a country with a high level of debt can grow just as fast as its peers.

Keywords: Panel tests of threshold effects, long-run relationships, estimation and inference, large dynamic heterogeneous panels, cross-section dependence, debt, inflation

JEL Classification: C23, E62, F34, H6

Suggested Citation

Chudik, Alexander and Mohaddes, Kamiar and Pesaran, M. Hashem and Raissi, Mehdi, Is There a Debt-Threshold Effect on Output Growth? (July 3, 2015). USC-INET Research Paper No. 15-18. Available at SSRN: https://ssrn.com/abstract=2627286 or http://dx.doi.org/10.2139/ssrn.2627286

Alexander Chudik (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States

Kamiar Mohaddes

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

Austin Robinson Building
Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom
+44 (0) 1223338904 (Phone)

HOME PAGE: http://people.ds.cam.ac.uk/km418

University of Cambridge - Girton College ( email )

Cambridge, CB3 0JG
United Kingdom
+44 (0)1223 338999 (Phone)
+44 (0)1223 338896 (Fax)

HOME PAGE: http://people.ds.cam.ac.uk/km418

M. Hashem Pesaran

University of Southern California - Department of Economics

3620 South Vermont Ave. Kaprielian (KAP) Hall 300
Los Angeles, CA 90089
United States

University of Cambridge - Trinity College (Cambridge) ( email )

United Kingdom

Mehdi Raissi

International Monetary Fund (IMF) - Asia and Pacific Department ( email )

700 19th Street NW
Washington, DC 20431
United States

HOME PAGE: http://https://sites.google.com/site/mehdiraissi/

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