Growth dynamic and public debt: An international overview

 Due to the global crisis and the expansive government policies, academics and policy makers have paid more attention to the impact of the high level of debt on the economic growth.

When the government deficit increases, economic growth can be affected negatively through higher interest rates discouraging investment and due to the increase in investors’ risk aversion favoring bonds of countries with low default risk. Therefore, if economic growth decreases, some policymakers believe that expansionary fiscal policies should be implemented in order to maintain a welfare state since the government revenues also decline. On the contrary, other authors indicate that higher levels of public debt reduce economic performance significantly and for this reason, they justify austerity policies to guarantee the confidence of economic agents and improve expectations.

The main objective of this paper is to provide new empirical evidence with respect to the influence of total (domestic plus external) gross general government debt on economic growth since this is a very controversial topic in fiscal policy. On the one hand, there are some supporters who believe fiscal stimulus is needed in order to expand aggregate demand and on the other hand, there are some authors who worry about unfavourable effects of excessive budget deficits and government debt in the long-run.

We employ data for a total of 115 countries, both developed and developing countries over an extended period of time (1960-2013). Banking, currency, debt and hyperinflation data are extracted from Laeven and Valencia (2008) and Reinhart and Rogoff (2010). We also investigate the impact of these crises on economic performance.

In order to combine the power of crosssectional and temporal dependence we use panel data econometrics. We investigate if there is a problem of serial correlation implementing Wooldridge (2002)’s test. In this paper, we also analyse another violation of Gauss-Markov assumptions (heteroscedasticity), the possibility that the variance of the errors of each country is not constant.

Our results suggest that higher levels of total government debt reduce economic growth significantly and financial crisis have a negative impact on it. Decomposing the financial crisis into the systemic banking crisis, currency crisis, sovereign debt crisis and hyperinflation also negatively affects economic performance.