Public debt and economic growth in Euro area countries. A wavelet approach
Abstract
In this paper we propose to analyze the dynamic of the relation between public debt and economic growth rate for Euro area countries by employing a wavelet approach, establishing thus both short-term and long-term correlations between these two variables. In this way we will present time-frequency dependencies between debt and economic growth and differentiate between short term and long-term effects. High levels of public debt have a negative impact on the economic output, because they entail concerns about debt sustainability. Non-linear analysis of the debt-growth nexus shows the existence of thresholds from which rising indebtedness can hamper economic growth. Using wavelet analysis, we demonstrate that there is a strong relation between public debt and economic growth, especially for high frequencies, public debt having a significant impact on economic growth in case of periods situated above 2 years for most Euro Zone member states.
High debt levels can cause serious effects on fiscal stability and therefore require fiscal consolidation in order to restore economic growth. Therefore, Euro Zone member states should implement prudent debt policies and establish clear limits for debt increase, in order to comply with fiscal sustainability and ensure conditions for preserving economic growth.
First published online 08 February 2021
Keyword : growth-debt nexus, sustainability, Euro area sovereign debt crisis, fiscal consolidation, continuous wavelet transform, wavelet coherence
How to Cite
Albu, A.-C., & Albu, L.-L. (2021). Public debt and economic growth in Euro area countries. A wavelet approach. Technological and Economic Development of Economy, 27(3), 602-625. https://doi.org/10.3846/tede.2021.14241
This work is licensed under a Creative Commons Attribution 4.0 International License.
References
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Kempa, B., & Khan, N. (2017). Spillover effects of debt and growth in the euro area: Evidence from a GVAR model. International Review of Economics & Finance, 49, 102–111.
Kim, Y. J., & Zhang, J. (2020). The relationship between debt and output (Working Paper No. 2020-30). Federal Reserve Bank of Chicago.
Kourtellos, A., Stengos, T., & Tan, C. M. (2013). The effect of public debt on growth in multiple regimes. Journal of Macroeconomics, 38, 35–43. https://doi.org/10.1016/j.jmacro.2013.08.023
Kumar, M., & Woo, J. (2010). Public debt and growth (IMF Working Paper). Fiscal Affairs Department.
Mauro, P., & Zhou, J. (2020). r − g < 0: Can we sleep more soundly? (Working Paper No. 20/52). International Monetary Fund, Washington, DC. https://doi.org/10.5089/9781513536071.001
Mencinger, J., Aristovnik, A., & Verbič, M. (2014). The impact of growing public debt on economic growth in the European Union. Amfiteatru Economic, 16(35), 403–414.
Mendoza, E. G., & Oviedo, P. M. (2004). Fiscal solvency and macroeconomic uncertainty in emerging markets: the tale of the tormented insurer [Conference presentation]. International Monetary Fund Conference on “Dollars, Debt, and Deficits – 60 Years after Bretton Woods”, Washington, DC.
Mika, A., & Zumer, T. (2017, December). Indebtedness in the EU: a drag or a catalyst for growth? (Working Paper Series No. 2118). European Central Bank.
Ogawa, K., Sterken, E., & Tokutsu, I. (2016). Public debt, economic growth and the real interest rate: A panel VAR approach to EU and OECD countries (Discussion Paper No. 955). Osaka University, Institute of Social and Economic Research (ISER), Osaka. https://doi.org/10.2139/ssrn.2726367
Reinhart, C., & Rogoff, K. (2010). Growth in a time of debt (Working Paper No. 15639). National Bureau of Economic Research. https://doi.org/10.3386/w15639
Reinhart, C., Reinhart, V., & Rogoff, K. (2012). Public debt overhangs: advanced-economy episodes since 1800. Journal of Economic Perspectives, 26(3), 69–86. https://doi.org/10.1257/jep.26.3.69
Rogoff, K. S. (2020). Falling real interest rates, rising debt: A free lunch? Journal of Policy Modelling, 42(4), 778–790. https://doi.org/10.1016/j.jpolmod.2020.03.004
Samarakoon, L. P. (2017). Contagion of the eurozone debt crisis. Journal of International Financial Markets, Institutions and Money, 49, 115–128. https://doi.org/10.1016/j.intfin.2017.03.001
Schmidbauer, H., & Roesch, A. (2018). WaveletComp 1.1: A guided tour through the R package. https://www.researchgate.net/publication/323836523_WaveletComp_11_A_guided_tour_through_the_R_package
Valiante, D. (2011, August). The Eurozone debt crisis: From its origins to a way forward (CEPS Policy Brief No. 251). https://doi.org/10.2139/ssrn.1928697
Wyplosz, C. (2014). The Eurozone crisis: A near-perfect case of mismanagement. Economia Marche Journal of Applied Economics, 33(1), 1–13.
Wyplosz, C. (2006). European Monetary Union: The dark sides of a major success. Economic Policy, 21(46), 207–261. https://doi.org/10.1111/j.1468-0327.2006.00158.x
Yener, H., Stengos, T., & Yazgan, M. E. (2014). Analysis of the seeds of debt crisis in Europe (Working Paper No. 1406). University of Guelph, Department of Economics and Finance. https://doi.org/10.2139/ssrn.2692089
Albu, L.-L. (2006). Trends in the interest rate – investment – GDP growth relationship. Romanian Journal of Economic Forecasting, 3(3), 5–13.
Ash, M., Basu, D., & Dube, A. (2017). Public debt and growth: an assessment of key findings on causality and thresholds (Umass Amherst Economics Working Paper No. 2017-10). https://scholarworks.umass.edu/econ_workingpaper/226
Attard, J. (2019). Public debt and economic growth nexus: a dynamic panel ARDL approach (MPRA Paper No. 96023). University Library of Munich, Germany.
Balázs, É. (2012). Public debt, economic growth and nonlinear effects: Myth or reality? (Working Paper No. 2012-44). University of Paris Nanterre.
Barro, R. J. (1990). Government spending in a simple model of endogenous growth. Journal of Political Economy, 98(S5), 103–125. https://doi.org/10.1086/261726
Baum, A., Checherita-Westphal, C., & Rother, P. (2012, July). Debt and growth. New evidence for the Euro area (Working Paper No. 1450). European Central Bank.
Bernardini, M., & Forni, L. (2017). Private and public debt: Are emerging markets at risk? (Working Paper No. 17/61). International Monetary Fund. https://doi.org/10.5089/9781475588170.001
Blanchard, O., Chouraqui, J. C., Hagemann, R. P., & Sartor, N. (1990). The sustainability of fiscal policy: new answers to an old question. Economic Studies, 15.
Burriel, P., Checherita-Westphal, C., Jacquinot, P., Stähler, N., & Schön, M. (2020). Economic consequences of high public debt: evidence from three large scale DSGE models (Working Paper No. 2486). European Central Bank. https://doi.org/10.2139/ssrn.3676264
Cecchetti, S., Mohanty, S., & Zampolli, F. (2011). Achieving growth amid fiscal imbalances: the real effects of debt. In Proceedings – Economic Policy Symposium – Jackson Hole (pp. 145–196). Federal Reserve Bank of Kansas City.
Checherita, C., & Rother, P. (2010). The Impact of high and growing government debt on economic growth. An empirical investigation for the euro area (Working Paper series No. 1237). European Central Bank.
Checherita-Westphal, C., & Rother, P. (2012). The impact of high government debt on economic growth and its channels: An empirical investigation for the euro area. European Economic Review, 56(7), 1392–1405. https://doi.org/10.1016/j.euroecorev.2012.06.007
Chudik, A., Mohaddes, K., Pesaran, H., & Raissi, M. (2017). Is there a debt-threshold effect on output growth? Review of Economics and Statistics, 99(1), 135–150. https://doi.org/10.1162/REST_a_00593
Clements, B. J., Bhattacharya, R., & Nguyen, T. Q. (2003). External debt, public investment, and growth in low-income countries (IMF Working Paper No. 249). International Monetary Fund, Washington, DC.
De Grauwe, P. (2010). What kind of governance for the eurozone? (CEPS Policy Brief No. 214). https://doi.org/10.2139/ssrn.1688256
Demaj, A. (2017). Macroeconomic determinants of sovereign risk: a debt sustainability analysis. Erasmus School of Economics.
Eberhardt, M., & Presbitero, A. (2015). Public debt and growth: Heterogeneity and non-linearity. Journal of International Economics, 97(1), 45–58. https://doi.org/10.1016/j.jinteco.2015.04.005
Eberhardt, M., & Presbitero, A. (2013). This time they are different: heterogeneity and nonlinearity in the relationship between debt and growth (IMF Working Paper No. 13/248). Research Department, International Monetary Fund. https://doi.org/10.5089/9781484309285.001
Elmendorf, D., & Mankiw, G. (1999). Government debt. In J. B. Taylor, & M. Woodford (Eds.), Handbook of macroeconomics (Vol. 1, part 3, pp. 1615–1669). Elsevier. https://doi.org/10.1016/S1574-0048(99)10038-7
Frieden, J., & Walter, S. (2017). Understanding the political economy of the Eurozone crisis. Annual Review of Political Science, 20(1), 371–390. https://doi.org/10.1146/annurev-polisci-051215-023101
Gómez-Puig, M., & Sosvilla-Rivero, S. (2018). Public debt and economic growth: further evidence for the euro area. Acta Oeconomica, 68(2), 209–229. https://doi.org/10.1556/032.2018.68.2.2
International Monetary Fund. (2003, September). Public debt in emerging markets. World Economic Outlook, International Monetary Fund.
Jiang, C., Li, X.-L., Chang, H.-L., & Su, C.-W. (2013). Uncovered interest parity and risk premium convergence in Central and Eastern European countries. Economic Modelling, 33, 204–208. https://doi.org/10.1016/j.econmod.2013.04.025
Kempa, B., & Khan, N. (2017). Spillover effects of debt and growth in the euro area: Evidence from a GVAR model. International Review of Economics & Finance, 49, 102–111.
Kim, Y. J., & Zhang, J. (2020). The relationship between debt and output (Working Paper No. 2020-30). Federal Reserve Bank of Chicago.
Kourtellos, A., Stengos, T., & Tan, C. M. (2013). The effect of public debt on growth in multiple regimes. Journal of Macroeconomics, 38, 35–43. https://doi.org/10.1016/j.jmacro.2013.08.023
Kumar, M., & Woo, J. (2010). Public debt and growth (IMF Working Paper). Fiscal Affairs Department.
Mauro, P., & Zhou, J. (2020). r − g < 0: Can we sleep more soundly? (Working Paper No. 20/52). International Monetary Fund, Washington, DC. https://doi.org/10.5089/9781513536071.001
Mencinger, J., Aristovnik, A., & Verbič, M. (2014). The impact of growing public debt on economic growth in the European Union. Amfiteatru Economic, 16(35), 403–414.
Mendoza, E. G., & Oviedo, P. M. (2004). Fiscal solvency and macroeconomic uncertainty in emerging markets: the tale of the tormented insurer [Conference presentation]. International Monetary Fund Conference on “Dollars, Debt, and Deficits – 60 Years after Bretton Woods”, Washington, DC.
Mika, A., & Zumer, T. (2017, December). Indebtedness in the EU: a drag or a catalyst for growth? (Working Paper Series No. 2118). European Central Bank.
Ogawa, K., Sterken, E., & Tokutsu, I. (2016). Public debt, economic growth and the real interest rate: A panel VAR approach to EU and OECD countries (Discussion Paper No. 955). Osaka University, Institute of Social and Economic Research (ISER), Osaka. https://doi.org/10.2139/ssrn.2726367
Reinhart, C., & Rogoff, K. (2010). Growth in a time of debt (Working Paper No. 15639). National Bureau of Economic Research. https://doi.org/10.3386/w15639
Reinhart, C., Reinhart, V., & Rogoff, K. (2012). Public debt overhangs: advanced-economy episodes since 1800. Journal of Economic Perspectives, 26(3), 69–86. https://doi.org/10.1257/jep.26.3.69
Rogoff, K. S. (2020). Falling real interest rates, rising debt: A free lunch? Journal of Policy Modelling, 42(4), 778–790. https://doi.org/10.1016/j.jpolmod.2020.03.004
Samarakoon, L. P. (2017). Contagion of the eurozone debt crisis. Journal of International Financial Markets, Institutions and Money, 49, 115–128. https://doi.org/10.1016/j.intfin.2017.03.001
Schmidbauer, H., & Roesch, A. (2018). WaveletComp 1.1: A guided tour through the R package. https://www.researchgate.net/publication/323836523_WaveletComp_11_A_guided_tour_through_the_R_package
Valiante, D. (2011, August). The Eurozone debt crisis: From its origins to a way forward (CEPS Policy Brief No. 251). https://doi.org/10.2139/ssrn.1928697
Wyplosz, C. (2014). The Eurozone crisis: A near-perfect case of mismanagement. Economia Marche Journal of Applied Economics, 33(1), 1–13.
Wyplosz, C. (2006). European Monetary Union: The dark sides of a major success. Economic Policy, 21(46), 207–261. https://doi.org/10.1111/j.1468-0327.2006.00158.x
Yener, H., Stengos, T., & Yazgan, M. E. (2014). Analysis of the seeds of debt crisis in Europe (Working Paper No. 1406). University of Guelph, Department of Economics and Finance. https://doi.org/10.2139/ssrn.2692089