An investigation of nonlinear effects of debt on growth

Abstract

The existence of threshold effects in public debt-growth relationship has been intensively discussed since Reinhart and Rogoff (2010). Using various country groups, a number of studies pointed out different turning points for public debt beyond which economic growth sharply slows down. This study investigates the threshold effects in debt-growth link for different types of debt employing a Panel Smooth Transition Regression framework. We basically find that nonlinearity of the relationship between debt and growth depend mostly on debt's structure. For a large panel data set which covers both developing and industrial countries, our results show that the direction of the effect of public debt on growth changes smoothly from positive to negative depending on the level of indebtedness. Furthermore, we find that debt threshold is lower for developing countries implying that public debt can hurt growth at lower levels of debt for those economies relative to advanced countries. We also find that short-term external debt and public long-term external debt generate more pronounced and strong negative impact on growth for high levels of indebtedness. © 2018