Debt Overhang in the Eurozone: A Spatial Panel Analysis

Abstract

The debt overhang hypothesis suggests that high debt levels retard prospects for GDP growth. We investigate the impact that debt overhang has had on recent GDP growth in the Eurozone, paying particular attention to the spillover effects that debt has on neighboring countries. We argue that in the Eurozone spatial effects are of crucial importance in modeling regional GDP growth, and find that a Spatial Durbin model is appropriate. We find strong evidence for the debt overhang hypothesis, confirming a concave relationship that has been found in other studies where low levels of debt can have a positive impact on GDP, but at some level a "turning point" occurs. The present study finds that this turning point occurs at a lower Debt/GDP ratio than found in prior studies, and separates out the direct and indirect (spillover) effects on neighboring countries' GDPs.

Public debt and regional inequality in India: patterns, determinants, and implications

“…The debt overhang hypothesis posits a region’s unmanageable debt can have a detrimental effect on economic growth via its negative effect on investor’s rate of return. Moreover, Romero and Burkey ( 2011 ) examine this phenomenon in the Eurozone with an explicit focus on the spillover effects and heterogeneity that debt has on neighboring countries. They utilized a spatial Durbin model and concluded a concave relationship exists between debt-to-GDP ratio and growth; and at a certain level, an inflection occurs.…”