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Revisiting the role of public debt in economic growth: The case of OECD countries

Mencinger, Jernej and Verbic, Miroslav and Aristovnik, Aleksander (2015): Revisiting the role of public debt in economic growth: The case of OECD countries. Published in: Engineering Economics , Vol. 26, No. 1 : pp. 61-66.

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The paper empirically explores the factor of public debt which considerably changes the transmission mechanism of fiscal policy effects to economic activity in the short term. We examined and evaluate the direct effect of higher indebtedness in the public sector on economic growth for a panel dataset of overall 36 countries (25 EU member states and 11 OECD countries). Our examination will shed light on the current debt problem by identifying a possible non-linear relationship between the level of public debt and economic growth, with an explicit focus to determine the threshold values for our sample of countries. Our sample is divided into subgroups distinguishing between so-called developed, covering the period 1980–2010, and emerging economies, covering the period 1995–2010. Extending our previous research we are particularly interested in the existence of a non-linear impact of government debt on the behaviour of GDP growth. In order to account for the impact of the level of the debt-to-GDP ratio on the real growth rate of GDP, we employ a panel estimation on a generalized economic growth model augmented with a debt variable, while also considering some methodological issues like the problems of heterogeneity and endogeneity. The results confirm the general theoretical assumption that at low levels of public debt the impact on growth is positive, whereas beyond a certain debt turning point a negative effect on growth prevails. Further, we calculated that the debt-to-GDP turning point, where the positive effect of accumulated public debt inverts into a negative effect, is roughly between 90% and 94% for developed economies. Yet for emerging countries the debt-to-GDP turning point is lower, namely between 44% and 45%. Therefore, we can confirm our hypothesis that the threshold value for emerging is lower than for the developed in our sample.

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