The relationship between public debt expansion and economic growth has attracted a lot
of interest in recent years, spurred by the sharp increase in government indebtedness in advanced
economies in the aftermath of the global financial crisis and the subsequent euro area sovereign
debt crisis.
Economists tend to agree that in the short run an increase in public debt, arising from fiscal expansion, stimulates aggregate demand, which should help the economy grow; the longer term economic impact of public debt accumulation, in contrast, is subject to a more heated debate—where views are not unified. Some argue for a negative long-term relationship between the two; others doubt any long-term association between them for low or moderate levels of public debt; yet others disregard any long-term association between debt and economic growth altogether. A better understanding of the long-term economic consequences of rising public debt is clearly warranted.
A careful empirical examination of this relationship using a panel of 40 advanced and emerging economies and four decades of data uncovers that a persistent accumulation of public debt over long periods is associated with a lower level of economic activity. Moreover, there is evidence that debt trajectory can have more important consequences for economic growth than the level of debt-to-GDP itself. There are several channels through which a continuous debt accumulation can harm economic growth, such as “crowding out” of private investment, higher long-term interest rates, more aggressive future taxation, and possibly weaker investor sentiment and greater uncertainty.
