Abstract
Currently countries are facing a new crisis caused by the COVID-19, which leads to the rise of government expenditures and additional borrowing. This situation highlights the importance of examine factors which determine the level of public debt that still sustains economic growth. A growing body of research supports the idea of a non-linear debt–growth relationship and estimates the threshold level above which debt becomes unsustainable and has a negative effect on output. The empirical evidence points out that there is no single sustainable debt threshold level that holds for all countries. This research complements scarce empirical evidence on the heterogeneous debt–growth relationship and provides some insights on the publicly available statistical indicators that might signal a relatively low/high expenditure multiplier and, at the same time, potentially unsustainable/sustainable growth stimulus through the use of borrowed funds. We test the hypothesis that the expenditure multiplier is shaping the impact of public debt on growth. Our empirical examination is based on panel data analysis in the groups of countries with expected relatively high and low expenditure multiplier. Research results show that a statistically significant negative marginal effect of debt on growth starts to manifest at a lower debt-to-GDP ratio when the expenditure multiplier is lower and vice-versa. The study shed some light on the sources of heterogeneity in a debt–growth relationship. We can conclude that countries with a high expenditure multiplier level can borrow more and sustain growth. In contrast, in countries with a lower expenditure multiplier, a relatively low debt level becomes unsustainable for growth.
Highlights
Accepted: 18 April 2021The economic crisis in 2008–2009 has led to an unprecedented increase in public debt.recovery has remained sluggish, raising serious concerns about the impact of public debt on economic growth
The results show that a smaller debt-to-GDP ratio is needed for the countries with a relatively very low expenditure multiplier to reach the point when debt starts to constrain growth compared to findings in Table 4 where the countries with scores < 8.15 are included
The empirical studies mostly concentrate on the relationship between debt level and the size of the fiscal multiplier, while the strand of empirical research on heterogeneous debt impact on output, as far as we know, mostly ignores the determinants of the fiscal multiplier as possible explanatory variables determining the debt tipping point, above which a growth-suppressive effect occurs
Summary
The economic crisis in 2008–2009 has led to an unprecedented increase in public debt. Our research complements scarce empirical evidence on the heterogeneous debt–growth relationship by raising the assumption that the expenditure multiplier is shaping the impact of public debt on growth and we put forward a hypothesis that countries with a higher expenditure multiplier have a higher debt threshold level. The empirical examination is based on the analysis of panel data and results indicate the positive debt threshold dependence on the expenditure multiplier, but irrespective of its size only low levels of public debt have positive and statistically significant links with economic growth. The rest of the paper is organised as follows: Section 2 discusses channels through which public debt can potentially have an impact on sustainable economic growth and the fiscal multiplier; it presents a review of empirical evidence on the relationship between public debt and the fiscal multiplier.
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