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Abstract
The new growth theories with an emphasis on fundamental determinants such as institutions suggest a non-linear cross-country growth process. In this paper, we investigate the public debt and economic growth relationship using the semi-parametric smooth coefficient approach that allows democracy to influence this relationship and parameter heterogeneity in the unknown functional form and addresses the endogeneity of variables. We find results consistent with the previous literature that identified a significant adverse effect of public debt on growth for the countries below a particular democracy level. However, we also find conclusive evidence that countries with high institutional quality have an adverse effect of public debt on growth for the period 1980–2009, as well as for the extended period including the years 2010–2014. A 10-percentage point increase in the debt-to-GDP ratio is associated with a 0.12% and 0.07% decrease in the subsequent 10-year period real GDP growth rate for the zero democracy countries and for the countries with a democracy score of 10, respectively.
Highlights
In the aftermath of the recent global financial crisis, government debt has increased substantially across the world
The OLS regression in Column 3 suggests that a 10 percentage point increase in the debt-to-GDP ratio was, on average, associated with a 0.060% decrease in the subsequent 10-year period real per capita GDP growth rate
We employed a semi-parametric smooth coefficient model with an endogenous variable in the nonparametric part to analyze the heterogeneous relationship between debt and growth with two different time frames
Summary
In the aftermath of the recent global financial crisis, government debt has increased substantially across the world. The public debt-to-GDP ratio rose on average from about 66% in 2007 to 105% by the end of 2015. Greece, Ireland, Japan, Portugal, Spain, and the United Kingdom, when compared to other countries, experienced a rapid and higher increase in public debt-to-GDP ratio between 2008 and 2012. A growing concern behind these facts is that countries may not achieve debt sustainability, implying higher vulnerability to an economic and financial crisis (Cecchetti et al (2010); Bohn (1995)). Over the last two centuries, there were twenty financial crises followed by debt build-up periods, which lasted more than a decade and are associated with lower growth than during other periods (Reinhart et al (2012)). A relevant policy question centers on the long-term growth effects of high public debt
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