Sovereign debt crisis and growth: Empirical evidence for the euro area

The recent euro area financial crisis has revived the debates on the macroeconomic impact of sovereign debts. Concerns of a sharp increase of fiscal deficit and government debt across Europe began to surface in early 2009 after Greece announced untenable budget deficits. As a result, market interest rates on sovereign debt started to rise in several EU member states requiring interventions and bailouts by the IMF and the European Commission. Although public debts increased strongly only in a few European countries, this became quickly a problem for the whole euro area. In the turmoil generated by the crisis, one country – Germany – managed to keep its financing interest rates particularly low and steady. The possible break-up of the eurozone crisis and the high sovereign bonds yields started to dissipate in July 2012 when the European Central Bank (ECB) president Mario Draghi promised to do "whatever it takes to preserve the euro". Although the conventional wisdom tells us that debt crisis produces harmful effects on economic growth, and that huge increases in public debt have frequently led to sovereign defaults, there is no consensus regarding both the magnitude of the output losses and the timing of the recovery after debt episodes. The current paper aims to investigate – from an empirical perspective - the short and the long-run impact of debt crisis on GDP in the case of 15 euro area countries over the quarterly period 2000-2015. We employ recent dynamic panel heterogeneity models introduced by Pesaran, Shin and Smith (1999) where the autodistributed lag (ARDL) specifications disentangle both the long and the short-term effects of debt crisis on growth. The preliminary results suggest that sovereign debt crisis produces significant long-lasting output losses particularly in the case of peripheral euro area countries.