The threshold effect of public debt on the twin imbalances: Evidence from MENA countries

Abstract

ABSTRACT The study explains the non-linear relationship between total public debt and twin imbalances, across a panel of 15 countries in the MENA (Middle East and North Africa) region from 2003 to 2019. A panel data threshold model with fixed effects proposed by Hansen (1999) estimates two debt-to-GDP thresholds (36.71% and 72.99%), which determine three debt-to-GDP intervals in the twin relationship. Our findings show two interesting results. First, if the level of public debt to GDP is less than 36.71%, the model determines a negative relationship between the budget balance and the current account. Twin deficits are confirmed exclusively if debt-to-GDP is in the interval between 36.71% and 72.99%. A twin divergence is also confirmed if public debt-to-GDP is more than 72.99% (e.g. as in Egypt and Lebanon). The results of this study show that there is not a single debt threshold applicable to all MENA countries, and the regression results are robust for different specifications and estimation techniques. As a result, policymakers may be able to adjust the current account deficit by lowering the public-debt ratio, reducing government-funded sterile programs, and implementing appropriate austerity measures to mitigate the effects of the financial crisis.