Does Public Debt Produce a Crowding out Effect for Public Investment in the EU?
46 Pages Posted: 24 Apr 2019 Last revised: 8 May 2019
Date Written: April 18, 2019
This paper exploits a panel dataset for 26 EU countries, between 1995 and 2015, to examine the extent to which increased levels of public debt have led to reduced public investment, the so-called ‘debt overhang’ hypothesis. To address endogeneity concerns, we use an instrumental variable approach based on a GMM estimation. Our results validate the debt overhang hypothesis and remain robust across various estimation techniques. The GMM specification with year dummies indicates that a 1% increase in public debt in the EU brings about a reduction in public investment of 0.03%. Moreover, we find evidence that:
1) the results are mainly driven by high-debt countries;
2) the negative impact of debt on investment is slightly smaller in the Eurozone than in the entire EU;
3) both the stock and flow of public debt play a role in reducing public investment with the impact of the latter that is found to be more profound.
Keywords: public investment, debt overhang, credit rationing
JEL Classification: E22, F34
Suggested Citation: Suggested Citation