Threshold Effects of Public Debt on Economic Growth in the Euro Area Economies

This paper sheds new light on the growth implications of public debt introducing a dynamic panel threshold model by accounting for regime dependent intercepts and focusing on 12 Euro zone economies over the 1980-2012 period. The threshold estimates for debt are estimated by using multiple threshold model advancing on Hansen (1999), Caner and Hansen (2004) and Bick (2010). The empirical results confirm the evidence for double threshold model. The estimated threshold values are 71.66% and 80.21%. The impact of debt on GDP growth is positive and highly significant whenever debt ratio is below 71.66%. This impact changes its direction and strength once debt ratio exceeds the first threshold value. Between 71.66% and 80.21%, debt ratio has negative impact on economic outcome. And above 80.21%, the impact remains negative but loses its strength. The decreasing negative relationship can be explained with the non-Keynesian impact of fiscal consolidation. The results also emphasize the role of regime dependent intercept. The exclusion of regime dependent intercept from the threshold model decreases the threshold value to around 39% and widens the 95% confidence interval substantially. In the absence of regime dependent intercept, debt ratio below the threshold value has wrong sign and loses its statistically significant impact on the economic growth. Thus, ignoring regime dependent intercepts may lead to biased estimates of the thresholds and the marginal impacts