Debt and Growth: New Evidence for the Euro Area
This paper uses European Commission Directorate General for Economic and Financial Affairs data to study the effects of sovereign data on economic growth.
This paper, written by University of Cambridge faculty of economics Anja Baum and European Central Bank Fiscal Policies Division researchers Cristina Checherita-Westphal and Philipp Rother, uses European Commission Directorate General for Economic and Financial Affairs data to study the effects of sovereign data on economic growth.
The paper studies how debt levels affect Gross Domestic Product (GDP) growth on a short-term basis, Baum and the researchers write.
“Our paper analyses the short-run impact of debt-to-GDP ratios on GDP growth, using one year lagged debt ratios in a non-linear threshold panel model,” Baum and the researchers wrote. “The empirical results suggest the following. The short-run impact of debt on GDP growth is positive, but decreases to close to zero and loses significance beyond public debt-to-GDP ratios of around 67 percent. This result is robust throughout most of our specifications, in the dynamic and non-dynamic threshold models alike. For high debt ratios, above 95 percent the impact of additional debt has a negative impact on economic activity.”
Increasing debt levels slow economic growth in most cases, Baum and the researchers write.
“Our results suggest that the positive short-term economic stimulus from additional debt decreases drastically when the initial debt level is high, and might even become negative,” Baum and the researchers wrote. “The reverse would imply that when debt ratios are very high, reducing it would have beneficial effects for annual growth.”