Growth and Debt: An Endogenous Smooth Coefficient Approach

Abstract

The new growth theories with an emphasis on fundamental determinants such as institutions suggest a non-linear cross-country growth process. In this paper, we investigate the public debt and economic growth relationship using the semi-parametric smooth coefficient approach that allows democracy to influence this relationship and parameter heterogeneity in the unknown functional form and addresses the endogeneity of variables. We find results consistent with the previous literature that identified a significant adverse effect of public debt on growth for the countries below a particular democracy level. However, we also find conclusive evidence that countries with high institutional quality have an adverse effect of public debt on growth for the period 1980–2009, as well as for the extended period including the years 2010–2014. A 10-percentage point increase in the debt-to-GDP ratio is associated with a 0.12% and 0.07% decrease in the subsequent 10-year period real GDP growth rate for the zero democracy countries and for the countries with a democracy score of 10, respectively.

Role of Uncertainty in Debt-Growth Nexus

“…In contrast, if the IRS is below its average value by between one and three standard deviations, the tipping point increases up to 150% and 180% of the debt-to-GDP ratio, respectively. These findings are in line with previous studies which investigated the relationship between public debt and growth in large panel data sets and found evidence for a varying debt threshold across countries (Caner et al, 2010;Afonso and Jalles, 2013;Kourtellos et al, 2013;Eberhardt and Presbitero, 2015;Duygu, 2018;Koroglu, 2019;Swamy 2020;Mohd Daud, 2020). Our results suggest that the level of uncertainty may be one of the factors explaining the observed threshold variation across countries.…”

“…A growing body of research (see Rahman et al, 2019;Koroglu, 2019;Bentour, 2020;Salmon and de Rugy, 2020 for a review of research results) confirms that the debt-growth relationship is not constant and depends on the debt level. The non-linear (more precisely, quadratic) relationship between debt and growth can be expressed by augmenting Equation 1 with the squared debt term and estimating the following specification:…”

“…Since the seminal paper of Reinhart and Rogoff (2010), the non-linear debt-growth relationship has been widely researched in the literature aiming to estimate a debt-to-GDP threshold at which the marginal impact of debt changes from positive to negative. Reviews of studies (see Rahman et al, 2019;Koroglu, 2019;Bentour, 2020;Salmon and de Rugy, 2020) clearly show no single debt threshold that is common to all countries. Therefore, a growing body of research aims to identify the factors on which the debt threshold is dependent.…”

Nonparametric Econometric Methods and Applications

“…Luong and Dokuchaev (2018) address the forecasting of realized volatility for a financial time series using the heterogeneous autoregressive model (HAR) and machine learning techniques, and they find that their proposed model offers improvements when applied to historical high-frequency data. Koroglu (2019) investigates the public debt and economic growth relationship using the semi-parametric smooth coefficient approach that allows democracy to influence this relationship and parameter heterogeneity in the unknown functional form and addresses the endogeneity of variables. Reza and Rilstone (2019) extend Horowitz's smoothed maximum score estimator to discrete-time duration models.…”