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

See all articles by Mattia Osvaldo Picarelli

Mattia Osvaldo Picarelli

European Stability Mechanism

Willem Vanlaer

Hasselt University; KPMG Belgium

Wim Marneffe

Hasselt University - Faculty of Applied Economics

Date Written: April 18, 2019

Abstract

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

Picarelli, Mattia Osvaldo and Vanlaer, Willem and Marneffe, Wim, Does Public Debt Produce a Crowding out Effect for Public Investment in the EU? (April 18, 2019). European Stability Mechanism Working Paper No. 36 (2019). Available at SSRN: https://ssrn.com/abstract=3376471 or http://dx.doi.org/10.2139/ssrn.3376471

Mattia Osvaldo Picarelli (Contact Author)

European Stability Mechanism ( email )

6a Circuit de la Foire Internationale
L-1347
Luxembourg

Willem Vanlaer

Hasselt University ( email )

Agoralaan - building D
Gebouw D
Diepenbeek, 3590
Belgium

KPMG Belgium ( email )

Bourgetlaan 40
1130
Brussels, Brussels 1130
Belgium

Wim Marneffe

Hasselt University - Faculty of Applied Economics ( email )

Agoralaan 30, Building D
Diepenbeek, 3590
Belgium

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