Is There a Debt-threshold Effect on Output Growth?

This paper studies the long-run impact of public debt expansion on economic growth and investigateswhether the debt-growth relation varies with the level of indebtedness. Our contribution is boththeoretical and empirical. On the theoretical side, we develop tests for threshold effects in the contextof dynamic heterogeneous panel data models with cross-sectionally dependent errors and illustrate,by means of Monte Carlo experiments, that they perform well in small samples. On the empiricalside, using data on a sample of 40 countries (grouped into advanced and developing) over the 1965-2010 period, we find no evidence for a universally applicable threshold effect in the relationshipbetween public debt and economic growth, once we account for the impact of global factors and theirspillover effects. Regardless of the threshold, however, we find significant negative long-run effectsof public debt build-up on output growth. Provided that public debt is on a downward trajectory, acountry with a high level of debt can grow just as fast as its peers in the long run.