Empirical Evidence on Factors Conditioning the Turning Point of the Public Debt–Growth Relationship

Abstract

This paper contributes to the limited literature on the factors conditioning the turning point of the public debt–growth relationship. A decade after the global financial crisis, when the debt ratio in many countries was still above pre-crisis levels, the COVID-19 pandemic again increased the pressure on public finances. It revived the debate on the ability to promote economic recovery through debt-financed government expenditure. However, more intense government borrowing increases its costs and uncertainty about future taxation policy, thus potentially disturbing private consumption, investment, and economic growth. In this paper, we estimate the thresholds of indicators on which the expenditure multiplier depends, which may already imply a risk that public debt will dampen economic growth. We use a methodology of structural threshold regression to examine the varying effects that debt might have on growth using consumption, investment, taxes, and imports as threshold variables, as well as several other factors suggested by previous contributions. The applied methodology allows for the addressing of parameter heterogeneity and endogeneity to be accounted for at the same time. The main results suggest that a positive debt effect is more likely if the conditions for a high expenditure multiplier are met, that an increase in the public-debt-to-GDP ratio is not necessarily deleterious to growth if shares of private consumption and investment in GDP are high, while the tax-revenue-to-GDP ratio is low.

Global experience in public debt reduction (on example of Sweden, Switzerland, and Iceland)

“…In general, only a few main reasons can be singled out, due to which a decrease in the level of public debt in the country can be observed. These are direct debt repayment due to an increase in revenues and decrease in budget expenditures, growth of inflation rate, which leads to depreciation of debt denominated in the respective currency, and rapid economic growth, which increases the level of GDP, and thus reduces the ratio of debt to this value (Butkus et al, 2021). Thus, when assessing the trends related to the reduction of public debt, it is worth assessing the causes of this phenomenon as well.…”

Impact of Deficit Financing and Trade Openness on Private Consumption in India

“…These were years characterised by scarcity, rationing, and patriotic self-restraint appeals, which led to an abnormally high rate of savings at a time when government budget deficits were huge. Butkus et al (2021a;2021b) found that an increase in public debt to GDP ratio is more likely to result in a positive debt effect on private consumption and investment. A positive relationship between public debt and private consumption and economic growth was found in China by Gu et al (2022).…”

Threshold effects of public debt on the tax burden: evidence from EU member states

“…However, the author found that the negative impact of debt on economic growth occurs when the debt reaches 60 per cent of GDP. Meanwhile, researchers Butkus et al (2021a) analyzing the breaking point of the relationship between public debt and growth, in terms of the tax burden, identify that low taxes (below the threshold level of 16.5 per cent of GDP tax revenue) are related to positive but insignificant effect of debt on economic growth. Leão (2015) found that very high public debt will not result a high tax burden or default because the central bank can keep government bond yields as low as necessary to make debt servicing negligible.…”