Nonlinear Effects of Public Debt on Economic Growth: The Case of Rwanda

Abstract

The purpose of this paper is to investigate the nonlinear impact of public debt on economic growth and establish the long and short run relationship between economic growth and its determinants in Rwanda. To this end, a quadratic polynomial function in debt combined with the autoregressive distributed lag (ARDL) bounds testing approach to co-integration have been employed for econometric analysis using time series data covering the period 1970-2020. Following previous empirical studies, this research assumed that at lower level, public debt may be growth-enhancing, while at higher level, it is detrimental to growth. Therefore, this study attempted to assess whether in the case of Rwanda, there exists a threshold level or a turning point above which the impact of public debt on economic growth shifts from positive to negative. The empirical results of this study strongly suggest the presence of an inverted U-shaped or concave relationship between public debt and economic growth in Rwanda. The turning point above which additional public debt becomes harmful to growth has been evaluated at a public debt-to-GDP ratio equal to 53.6%. The estimated threshold is relatively higher than the public debt convergence policy benchmark of 50% of GDP adopted in Rwanda within the East African Community. This result would be useful for policy makers in the design of a well-informed macroeconomic and public debt management strategy.