Partners in Debt: An Endogenous Nonlinear Analysis of Interaction of Public and Private Debt on Growth

Abstract

This paper analyzes how the interaction of public and private debt influences economic growth. Both debt variables are treated as endogenous and subject to regime switch, with the interaction term being the threshold variable. We test whether this interaction variable causes a nonlinear relationship. We find strong evidence for a threshold effect. The threshold variable is endogenous, unlike its treatment in the previous literature. Using data from 29 OECD countries from 1995-2014, the thresh old effect of the interaction between the public and private debt variables and economic growth is found to be negative and significant when it reaches the level of 137%. We also decompose private debt into household and corporate debt. We find that the public and private debt interaction is likely to operate through the channels of household debt and public debt. For a robustness check, we examine the sensitivity of the threshold effects to banking crises, output volatility, and institutional quality, different time periods, and alternative models.