Public Capital Expenditure and Debt Dynamics: Evidence from the European Union

Abstract

This paper investigates the relationship between public capital expenditure and public debt in the European Union (EU) on a panel of fifteen countries over the sample period 1980-2013. We find robust evidence of a negative cointegrating relation, according to which increases in the capital expenditure-GDP ratio cause reductions in the debt-GDP ratio in the long run. Our empirical results suggest that current EU fiscal austerity can trigger upward debt spirals if cuts in total expenditure disregard its composition. Consistently with the “golden rule of public finance”, EU fiscal rules should allow for higher levels of capital expenditure in order to foster debt consolidation through growth dividends.