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Government Debt and Economic Growth: Decomposing the Cause–Effect Relationship

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  • Vighneswara Swamy

    (Institute of Economic Growth, Delhi)

Abstract

Rising government debt levels in the aftermath of the global financial crisis and the ongoing Eurozone debt crisis have necessitated the revival of the academic and policy debate on the impact of growing debt levels on growth. This study provides a data-rich analysis of the dynamics of government debt and economic growth for a longer period (1960–2009). It spans different debt regimes and involves a worldwide sample of countries that is more representative than that of studies confined to advanced countries. This study observes a negative relationship between government debt and growth. The point estimates of the range of econometric specifications suggest a 10-percentage-point increase in the debt-to-GDP ratio is associated with a 23-basis-point reduction in average growth. Our results establish the non-linear relationship between debt and growth. Further, by employing panel vector auto regressions (PVAR) approach, this study decomposes the cause-and-effect relationship between debt and growth, and answers the question: Does high debt lead to low growth, or does low growth lead to high debt? The results derived from the impulse–response functions and variance decomposition show the evidence of a long-term effect of debt on economic growth. The results indicate that the effect is not uniform for all countries, but depends mostly on the debt regimes and other important macroeconomic variables, like inflation, trade openness, general government final consumption expenditure, and foreign direct investment.Length: 31 pages

Suggested Citation

  • Vighneswara Swamy, 2015. "Government Debt and Economic Growth: Decomposing the Cause–Effect Relationship," IEG Working Papers 360 JEL Classification:C3, Institute of Economic Growth.
    • Handle: RePEc:awe:wpaper:360
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    References listed on IDEAS

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