Partners in debt: An endogenous non-linear analysis of the effects of public and private debt on growth

Abstract

This paper offers an empirical analysis of how public and private debt jointly influence economic growth. We consider the endogeneity and interlink of two debt variables which are subject to regime switch in a dynamic panel data model. Using data from 29 OECD countries, the threshold effect of the interaction of the public and private debt on economic growth is found to be negative and significant when the aggregate debt to GDP ratio reaches 220%, beyond which the marginal effect of public (or private) debt further increases on top of the non-interactive effect. It is shown that the true effect of individual debt is largely underestimated if the interactive effect is omitted. We also decompose private debt into household and corporate debt and show that the public–private debt interaction is likely operating through the channels of household debt and public debt. We examine the robustness of the threshold effects to banking crises, output volatility, institutional quality, tax, private and public pension savings, participation rate as well as potential outliers.