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OUR ECONOMY

Does Debt Have Threshold Effects on Medium-Term Growth? Evidence from European Union Countries

Nejc Fir

Abstract


Debt has become an important factor in economic activity and its extent
has incentivized many researchers to incorporate it into contemporary
growth models. On the positive side, debt has the ability to smoothen private
consumption, firms’ investment and government expenditure in relation
to their corresponding income, subsequently leading to better capital
allocation. However, the history of debt defaults and lessons from European
sovereign debt crises, which were accompanied by strict austerity measures,
have warned us about the danger of debt overhang and unsustainable debt
burdens. This paper tackles the question of the existence of a turning point,
at which the negative effects of debt start to prevail in the economic process.
In the sample of European Union countries in the period from 1995 to 2019,
the author of this paper investigated the presence of threshold effects of
government, non-financial corporate and household debt on medium-term
growth following the paper by Mika and Žumer (2017). The author first
confirmed the concave-shaped relationship between public debt and growth
with a threshold of 111.6% of GDP, based on Eurostat debt-to-GDP data. In
contrast, private debt was found to have first lag effects with an accompanied
convex-shaped relationship between private debt and growth and with a
corresponding threshold of 149.8% of GDP. Next, the author divided private
debt into non-financial corporate and household debt to investigate a
more detailed relationship between debt and growth. Corresponding to the
Global Debt Database, the concave-shaped relationship between public debt
and growth was confirmed with a threshold of 104.8% of GDP. Both of the
investigated types of private debt confirmed the previously explored lagged
impact on medium-term growth and a convex-shaped relationship between
non-financial corporate and household debt and growth. The threshold
of non-financial corporate debt stands at 138.3% of GDP, while that for
household debt is 145.1% of GDP. Considering the presence of thresholds
may offer an important message to economic policymakers, as timely and
suitable governance can lead to either higher economic growth or prevent
adverse effects of excessive indebtedness.

Keywords


Indebtedness, Medium-term growth, Threshold effects

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