PUBLIC DEBT AND ECONOMIC GROWTH IN EURO AREA COUNTRIES. A WAVELET APPROACH

Ada-Cristina Albu,Lucian-Liviu Albu

doi:10.3846/tede.2021.14241

Ada-Cristina Albu, Lucian-Liviu Albu

Open Access

https://doi.org/10.3846/tede.2021.14241

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Abstract

In this paper we propose to analyze the dynamic of the relation between public debt and economic growth rate for Euro area countries by employing a wavelet approach, establishing thus both short-term and long-term correlations between these two variables. In this way we will present time-frequency dependencies between debt and economic growth and differentiate between short term and long-term effects. High levels of public debt have a negative impact on the economic output, because they entail concerns about debt sustainability. Non-linear analysis of the debt-growth nexus shows the existence of thresholds from which rising indebtedness can hamper economic growth. Using wavelet analysis, we demonstrate that there is a strong relation between public debt and economic growth, especially for high frequencies, public debt having a significant impact on economic growth in case of periods situated above 2 years for most Euro Zone member states. High debt levels can cause serious effects on fiscal stability and therefore require fiscal consolidation in order to restore economic growth. Therefore, Euro Zone member states should implement prudent debt policies and establish clear limits for debt increase, in order to comply with fiscal sustainability and ensure conditions for preserving economic growth.

Highlights

After the global financial crisis of 2007, the sustainability of high debt ratios emerged as a serious concern for states and governments, due to an impressive increase in public debt levels worldwide
In order to investigate the impact of the high levels of debt on macroeconomics, we study in this paper the relation between public debt and economic growth for Euro Zone (EZ) countries during 2000–2019, including both the financial crisis and the sovereign debt crisis
Our article is structured as follows: Section 1 contains the literature review, in Section 2 we present some theoretical considerations regarding public debt sustainability, Section 3 introduces the method of continuous wavelet transform used in this paper, while Section 4 contains the results of the wavelet analysis for debt-economic growth nexus using quarterly data for the period 2000–2019 for Euro area member states and Section 5 robustness checks

Summary

Introduction

After the global financial crisis of 2007, the sustainability of high debt ratios emerged as a serious concern for states and governments, due to an impressive increase in public debt levels worldwide. Euro Zone (EZ) countries sovereign debt crisis (SDC), which followed the financial crisis, showed that public debt must be monitored more strictly, in order to avoid situations of payment incapacity or sovereign default. The sovereign debt crisis in EZ raised again the issue of the necessity to complete the European Monetary Union (EMU), implemented through a common currency area, with a Fiscal Union and a Banking Union. The convergence of monetary and fiscal policies within Euro area is essential in order to ensure stability of the currency union

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