Austerity

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Butkus et al

Substantial attention has been paid to the examination of economic growth—public debt nexus. In theory we can find arguments for positive, negative or neutral effect of government borrowing on economy. From Keynesian point of view, expansionary fiscal policy leads to higher debt level and simultaneously stimulates GDP growth, especially through the mechanism of expenditure multiplier. However, this positive effect is expected mostly in the short-run. The neo-classical theory asserts harmful impact of public debt, known as crowding-out effect. Government borrowing can result in higher interest rates and thus reduce private investment and growth. Ricardian equivalence suggests that public deficit and debt do not make influence on growth. Increase in demand because of debt-financed government consumption is offset by rising savings. People save more as they prepare for future tax increase, when it will be necessary to repay high public debt.

In the sample of 20 developed countries, Reinhart and Rogoff (2010) find negative relationship between debt and economic growth, when public debt to GDP ratio exceeds 90 percent. Pattillo et al. (2011) estimate much lower threshold for the panel of 93 developing countries. The debt levels above 30–40% of the GDP start hindering per capita growth. Checherita-Westphal et al. (2014) conclude that optimal debt to the GDP ratio for Euro area is around 50% and 65% is for the sample of 22 OECD countries. Baum et al. (2013) perform regression analyses for 12 Euro zone countries and indicate that the negative debt-growth relationship occurs when the debt level exceeds 95% of the GDP. To avoid reverse causality Woo and Kumar (2015) examine the impact of initial debt level on subsequent growth (5–20 years) of real GDP per capita in a panel of 38 advanced and emerging economies. They found some evidence for the threshold of initial debt-to-GDP ratio of 90%, having larger negative effect on the growth in the future. Afonso and Jalles (2013), Herndon et al. (2014) obtain the opposite results. They found no evidence that the GDP growth of the countries with high levels of debt (above 90% to GDP) is different from ones with low debt ratios...

Most empirical studies confirm the adverse impact of government debt on growth. The growing number of recent works investigates the optimal level of government debt and supports the idea of non-linear, an inverted U-shaped debt-growth relationship...

The estimated threshold value above which the impact of debt on growth becomes harmful varies between 30–95% of GDP and gives a little insight into what the optimal level of debt is. As Panizza and Presbitero point out, it might be impossible to find a single debt tipping point that holds for all countries, because a range of factors can shape the impact of debt on growth..