Government Debt and Economic Growth: Estimating the Debt Thresholds and Debt Intolerance

Abstract

The surge of government debt during the post-global financial crisis and the ongoing euro zone sovereign debt crisis has begun raising concerns whether government debt levels have hit the tipping points. This study offers to contribute in the following ways: First, we find out whether the relationship between government debt and real GDP growth is weak for debt/GDP ratios below 90%. Second, we estimate different thresholds for groups of economies based on their debt regimes, political economy structures and types of political governance, geographical considerations, and income levels. Third, we find out whether there is a declining negative effect beyond the debt threshold. Our results find the debt thresholds to vary in the range of 84 to 114 percent of GDP. We estimate that every additional 10 percent rise in debt-to-GDP ratio beyond the debt threshold costs 10 to 30 basis points of annual average real GDP growth. We find that different groups of countries experience debt threshold at different levels. Debt thresholds are dependent not necessarily on economic factors alone, but on other factors such as political economies and governance structures, geographies etc. Debt thresholds are sensitive to horizon of analysis.