Readers Question: To what extent are higher government debt levels a constraint on economic growth?
There has been much debate about the extent to which high levels of government debt might slow down rates of economic growth. In particular, a 2010 paper “Growth in a Time of Debt,” by Carmen Reinhart and Kenneth Rogoff seemed to suggest that GDP growth significantly falls once government-debt levels exceed 90% of GDP.
This paper was used as a justification for austerity in both the US and EU, but the paper has recently received substantial criticism. Firstly because an excel coding error left out several countries data. Secondly, because it is not clear whether high debt causes low growth or low growth causes higher debt levels.
In 2010 two American Economists Carmen Reinhart and Kenneth Rogoff, circulated a paper, this paper suggested that once government debt reached 90% of GDP it led to a sharp drop off in economic growth.
It was very influential in 2010 as there was a political interest in reducing debt. However, the paper was later criticised on numerous fronts
They omitted some data
There was an excel coding error
They used questionable statistical analysis.
Later researchers couldn’t replicate their results and only found a very weak link between debt and lower growth rates.
Also, they were criticised for their assertion that
“growth drops off sharply when debt exceeds 90 percent of GDP”.
Because even if there is data suggesting a relationship between growth and debt. It remains another question of which factor causes the other factor. It could be that countries with slow growth tend to accumulate debt to GDP (in a recession, you expect debt to GDP to rise. A fairer statement is to say
“countries with debt over 90% of GDP tend to have slower growth than countries with debt below 90% of GDP”
Public debt and Growth OECD
There is a reasonably good summary at the Economist here – relationship between growth and debt. Source: De Long. The relationship between growth and debt amongst G7 in post-war period. However, you have to be careful from reading too much in this. E.g. Japan’s post-war miracle with growth of 10% + is different era to today’s situation.
But, it is worth mentioning other papers have given a mixture of results.
A 2010 IMF paper turns up “some evidence” of a 90% threshold.
A 2011 study by the Bank for International Settlements identifies a threshold of 85%.
A 2012 IMF paper found “there is no particular threshold that consistently precedes sub-par growth performance.”
Theory behind Growth and debt link
Let us examine the theory behind the possible link between government debt and economic growth
Firstly, how might high government debt levels constrain economic growth?
Crowding Out. Higher government debt usually requires the government to borrow from the private sector. Therefore, with higher government debt, there is likely to be a fall in private sector investment as the private sector use funds to buy government bonds. In addition, some economists argue that government spending tends to be more inefficient than the private sector. For example, if the government borrow to finance higher pension commitments, there will be less impetus to boosting economic growth than if the private sector had been free to invest itself.
However, crowding out is only likely to occur if the government borrows when the economy is close to full capacity. If the government borrow when savings are high and the economy is stuck in a recession, then there will not be crowding out, but an actual injection of spending into the economy. The government debt is financing spending which otherwise would not occur. In other words, in a recession, higher debt could cause higher growth rates than countries who try to cut budget deficits. The fact European economies have entered a double-dip recession after pursuing austerity policies, suggests there is empirical support for this.
High debt levels eventually exhaust private saving. The argument is that moderate levels of government debt can be financed by domestic saving levels, and therefore there isn’t crowding out. However, if government debt increases above a certain level, it will be harder to finance the debt from ordinary savings. The government will need to divert resources from investment and encourage more saving through higher bond yields. The government may also rely on more on volatile foreign borrowing.
However, even if government debt does lead to a fall in private sector investment and spending, in theory, aggregate demand should be unaffected. If government spending increases by £5bn, and is financed by borrowing £5bn from the private sector, overall AD is unaffected by the shift in the sector of the economy from the private to public sector.
Higher bond yields. A concern about higher debt levels is that there comes a point when markets start to fear government default. For example, suppose government debt rises above 100% of GDP, bond traders may feel that there is now a risk governments could actually default (or resort to inflation which is effective default) and they could potentially lose money. Therefore, markets will demand higher interest rates to compensate for the increased risk of default. These higher bond yields, will increase debt interest payments and also push up interest rates around the economy. The higher interest rates will cause lower investment and lower spending. Thus we can have a reason why higher debt could lead to lower economic growth. Because higher debt pushes up interest rates. In the Eurozone, we saw several countries with rising debt levels have sharp increases in bond yields. Following these higher bond yields, growth rates fell.\
However, there is no guarantee that higher government debt levels will cause higher bond yields. Between 2008-13, the UK and US have seen substantial increases in the level of public sector debt, but bond yields have fallen. In the post war period, the UK had debt levels of over 200% of GDP, but bond yields were not excessive (and growth rates high). There is also no clear link between debt levels and bond yields. For example, gross public sector debt in Japan is over 230% of GDP, but bond yields low. Spain saw rising bond yields with debt of less than 60% of GDP. The real problem for the Eurozone was not public sector debt, but the lack of a Central Bank to intervene in the bond market. In 2012, when the ECB did finally intervene, bond yields fell – despite growing debt levels.
Confidence. Another argument is that high debt levels cause a loss of confidence. For example, the business may expect future tax increases to repay debt. Also, if business fears a government default and / or potential inflation, they may reduce spending and investment. This loss of confidence could lead to lower economic growth.
However, it is hard to find any strong evidence that consumer and business confidence is directly affected by government debt levels. The EU hoped that austerity policies of 2011 would ‘improve confidence‘. But, actually, the deficit reduction policies caused a collapse in confidence and economic growth. Consumers and firms confidence is based on more immediate factors, like employment, real wages and house prices than government debt levels.
The causation issue
Low growth will cause higher debt to GDP ratio. If we have low or negative economic growth, we would expect debt to GDP ratios to rise. With negative growth, tax receipts fall, and spending on unemployment benefits increase. Also, falling GDP will increase the debt to GDP ratio. If we look at countries like Spain, Portugal and Greece during 2010-13, we see high levels of debt and low economic growth. But, these are countries trying to reduce budget deficits through spending cuts. The biggest factor behind rising debt levels is the continued recession.
Conclusion
It is hard to make generalisations about the effect of debt on economic growth because so many factors affect growth. For example, in the 1920s, the UK had a high debt to GDP ratio and low rates of economic growth. In the 1940s and 1950s, the UK had even higher levels of government debt, but economic growth was quite strong. Irish government debt was very high in the late 1980s and early 1990s, but this was not a constraint to the economic boom of the 1990s.
There is no direct link between levels of debt and rates of economic growth
There can be circumstances when high debt levels act as a constraint on economic growth. If markets were really concerned about the ability of the government to repay, it may cause higher bond yields, lower confidence and reduce investment. However, if a country has its own Central Bank, there are not many examples of countries of actually have these rapidly rising bond yields in response to debt fears.
Further evaluation
It depends on why the government is borrowing. Is the government borrowing to finance public investment or is it borrowing because of a rapidly ageing population and the need to spend more on pensions and health care.
Is monetary policy accommodative? If government debt is high, but there is a tightening of monetary policy and overvalued exchange rate, then you would expect lower growth. High debt, but expansionary monetary policy would give a different result.
What is the past record of the country? A country with no history of default may be able to borrow substantially more than a country with a track record of default
Is there a patriotic incentive to buy debt? e.g. in World wars, the UK was able to tap patriotic sentiment to sell bonds and finance government debt at low-interest rates.
Do investors fear inflation? If savers fear, high debt will be inflated away, they may refuse to buy bonds
Related
You can read more at our privacy page, where you can change preferences whenever you wish.
Manage consent
Privacy Overview
This website uses cookies to improve your experience while you navigate through the website. Out of these, the cookies that are categorized as necessary are stored on your browser as they are essential for the working of basic functionalities of the website. We also use third-party cookies that help us analyze and understand how you use this website. These cookies will be stored in your browser only with your consent. You also have the option to opt-out of these cookies. But opting out of some of these cookies may affect your browsing experience.
Necessary cookies are absolutely essential for the website to function properly. These cookies ensure basic functionalities and security features of the website, anonymously.
Cookie
Duration
Description
__cfduid
1 month
The cookie is used by cdn services like CloudFlare to identify individual clients behind a shared IP address and apply security settings on a per-client basis. It does not correspond to any user ID in the web application and does not store any personally identifiable information.
AWSALBCORS
7 days
This cookie is used for load balancing services provded by Amazon inorder to optimize the user experience. Amazon has updated the ALB and CLB so that customers can continue to use the CORS request with stickness.
cookielawinfo-checkbox-advertisement
1 year
The cookie is set by GDPR cookie consent to record the user consent for the cookies in the category "Advertisement".
cookielawinfo-checkbox-analytics
11 months
This cookie is set by GDPR Cookie Consent plugin. The cookie is used to store the user consent for the cookies in the category "Analytics".
cookielawinfo-checkbox-functional
11 months
The cookie is set by GDPR cookie consent to record the user consent for the cookies in the category "Functional".
cookielawinfo-checkbox-necessary
11 months
This cookie is set by GDPR Cookie Consent plugin. The cookies is used to store the user consent for the cookies in the category "Necessary".
cookielawinfo-checkbox-others
11 months
This cookie is set by GDPR Cookie Consent plugin. The cookie is used to store the user consent for the cookies in the category "Other.
cookielawinfo-checkbox-performance
11 months
This cookie is set by GDPR Cookie Consent plugin. The cookie is used to store the user consent for the cookies in the category "Performance".
gdpr_status
6 months 2 days
This cookie is set by the provider Media.net. This cookie is used to check the status whether the user has accepted the cookie consent box. It also helps in not showing the cookie consent box upon re-entry to the website.
SERVERID
past
This cookie is used to assign the user to a specific server, thus to provide a improved and faster server time. It remembers which server had delivered the last page on to the browser. It also helps in load balancing.
viewed_cookie_policy
11 months
The cookie is set by the GDPR Cookie Consent plugin and is used to store whether or not user has consented to the use of cookies. It does not store any personal data.
Functional cookies help to perform certain functionalities like sharing the content of the website on social media platforms, collect feedbacks, and other third-party features.
Cookie
Duration
Description
bcookie
2 years
This cookie is set by linkedIn. The purpose of the cookie is to enable LinkedIn functionalities on the page.
lang
session
This cookie is used to store the language preferences of a user to serve up content in that stored language the next time user visit the website.
lidc
1 day
This cookie is set by LinkedIn and used for routing.
na_id
1 year 1 month
This cookie is set by Addthis.com to enable sharing of links on social media platforms like Facebook and Twitter
na_rn
1 month
This cookie is used to recognize the visitor upon re-entry. This cookie allows to collect information on user behaviour and allows sharing function provided by Addthis.com
na_sc_e
1 month
This cookie is used to recognize the visitor upon re-entry. This cookie allows to collect information on user behaviour and allows sharing function provided by Addthis.com
na_sr
1 month
This cookie is set by Addthis.com. This cookie is used for sharing of links on social media platforms.
na_srp
1 minute
This cookie is used to recognize the visitor upon re-entry. This cookie allows to collect information on user behaviour and allows sharing function provided by Addthis.com
na_tc
1 year 1 month
This cookie is set by the provider Addthis. This cookie is used for social media sharing tracking service.
ouid
1 year 1 month
The cookie is set by Addthis which enables the content of the website to be shared across different networking and social sharing websites.
pid
1 year 1 month
Helps users identify the users and lets the users use twitter related features from the webpage they are visiting.
Performance cookies are used to understand and analyze the key performance indexes of the website which helps in delivering a better user experience for the visitors.
Cookie
Duration
Description
_gat
1 minute
This cookies is installed by Google Universal Analytics to throttle the request rate to limit the colllection of data on high traffic sites.
d
3 months
This cookie tracks anonymous information on how visitors use the website.
guid2
1 year
This cookie is set by the provider Delta projects. This cookie is used to track the individual sessions on the website, which allows the website to compile statistical data from multiple visits. This generated data is used for creating leads for marketing purposes.
YSC
session
This cookies is set by Youtube and is used to track the views of embedded videos.
Analytical cookies are used to understand how visitors interact with the website. These cookies help provide information on metrics the number of visitors, bounce rate, traffic source, etc.
Cookie
Duration
Description
__gads
1 year 24 days
This cookie is set by Google and stored under the name dounleclick.com. This cookie is used to track how many times users see a particular advert which helps in measuring the success of the campaign and calculate the revenue generated by the campaign. These cookies can only be read from the domain that it is set on so it will not track any data while browsing through another sites.
_ga
2 years
This cookie is installed by Google Analytics. The cookie is used to calculate visitor, session, campaign data and keep track of site usage for the site's analytics report. The cookies store information anonymously and assign a randomly generated number to identify unique visitors.
_gid
1 day
This cookie is installed by Google Analytics. The cookie is used to store information of how visitors use a website and helps in creating an analytics report of how the website is doing. The data collected including the number visitors, the source where they have come from, and the pages visted in an anonymous form.
_gu
1 month
This cookie is set by the provider Getsitecontrol. This cookie is used to distinguish the users.
ANON_ID
3 months
This cookie is provided by Tribalfusion. The cookie is used to give a unique number to visitors, and collects data on user behaviour like what page have been visited. This cookie also helps to understand which sale has been generated by as a result of the advertisement served by third party.
APID
1 year
This cookie is used to store information of how a user behaves on multiple websites. This information is them used to customize the relevant ads to be displayed to the users.
eud
1 year 24 days
The domain of this cookie is owned by Rocketfuel. This cookie is used to sync with partner systems to identify the users. This cookie contains partner user IDs and last successful match time.
GUC
This cookie is set by the provider Yahoo. This cookie is used for Yahoo conversion tracking.
is_unique
5 years
This cookie is set by StatCounter Anaytics. The cookie is used to determine whether a user is a first-time or a returning visitor and to estimate the accumulated unique visits per site.
sc_is_visitor_unique
2 years
This cookie is used to store a random ID to avoid counting a visitor more than once.
sync-his
1 year
The domain of this cookie is owned by Videology.This cookie is used in association with the cookie "tidal_ttid". This cookie is used to keep track of the last day when the user ID synced with a partner. This is done by matching "tidal_ttid" with a partner's user ID inorder to recognise the same user.
UserID1
3 months
The cookie sets a unique anonymous ID for a website visitor. This ID is used to continue to identify users across different sessions and track their activities on the website. The data collected is used for analysis.
Advertisement cookies are used to provide visitors with relevant ads and marketing campaigns. These cookies track visitors across websites and collect information to provide customized ads.
Cookie
Duration
Description
__kuid
7 days
This cookie is used to collect information of the visitors, this informations is then stored as a ID string. The ID information strings is used to target groups having similar preferences, or for targeted ads.
_rxuuid
1 year
The main purpose of this cookie is targeting, advertesing and effective marketing. This cookie is used to set a unique ID to the visitors, which allow third party advertisers to target the visitors with relevant advertisement up to 1 year.
ab
1 year
This domain of this cookie is owned by agkn. The cookie is used for targeting and advertising purposes.
ANON_ID_old
3 months
This cookie helps to categorise the users interest and to create profiles in terms of resales of targeted marketing. This cookie is used to collect user information such as what pages have been viewed on the website for creating profiles.
APIDTS
1 day
This cookie is set by the provider Yahoo.com. This coookie is used to collect data on visitor preference and behaviour on website inorder to serve them with relevant content and advertisement.
CMID
1 year
The cookie is set by CasaleMedia. The cookie is used to collect information about the usage behavior for targeted advertising.
CMPRO
3 months
This cookie is set by Casalemedia and is used for targeted advertisement purposes.
CMPS
3 months
This cookie is set by Casalemedia and is used for targeted advertisement purposes.
CMRUM3
1 year
This cookie is set by Casalemedia and is used for targeted advertisement purposes.
CMST
1 day
The cookie is set by CasaleMedia. The cookie is used to collect information about the usage behavior for targeted advertising.
DSID
1 hour
This cookie is setup by doubleclick.net. This cookie is used by Google to make advertising more engaging to users and are stored under doubleclick.net. It contains an encrypted unique ID.
dyn_u
1 year
This cookie is used collect information on user behaviour and interaction for serving them with relevant ads and to optimize the website.
everest_g_v2
1 year
The cookie is set under eversttech.net domain. The purpose of the cookie is to map clicks to other events on the client's website.
gi_u
1 year
The cookie is set by Adhigh. The cookie is used for ad serving purposes and track user online behaviour. The cookie also stores the number of time the same ad was delivered, it shows the effectiveness of each ad.
google_push
5 minutes
This cookie is set by the Bidswitch. This cookie is used to collect statistical data related to the user website visit such as the number of visits, average time spent on the website and what pages have been loaded. This collected information is used to sort out the users based on demographics and geographical locations inorder to serve them with relevant online advertising.
HAPLB5S
This cookie is set by the provider Sonobi. This cookie is used to track the visitors on multiple webiste to serve them with relevant ads.
id
3 months
The main purpose of this cookie is targeting and advertising. It is used to create a profile of the user's interest and to show relevant ads on their site. This Cookie is set by DoubleClick which is owned by Google.
IDE
1 year 24 days
Used by Google DoubleClick and stores information about how the user uses the website and any other advertisement before visiting the website. This is used to present users with ads that are relevant to them according to the user profile.
IDSYNC
1 year
This cookie is used for advertising purposes.
KADUSERCOOKIE
3 months
The cookie is set by pubmatic.com for identifying the visitors' website or device from which they visit PubMatic's partners' website.
KTPCACOOKIE
1 day
This cookie is set by pubmatic.com for the purpose of checking if third-party cookies are enabled on the user's website.
ljt_reader
1 year
This is a Lijit Advertising Platform cookie. The cookie is used for recognizing the browser or device when users return to their site or one of their partner's site.
mc
1 year 1 month
This cookie is associated with Quantserve to track anonymously how a user interact with the website.
mdata
1 year 1 month
The domain of this cookie is owned by Media Innovation group. This cookie registers a unique ID used to identify a visitor on their revisit inorder to serve them targeted ads.
mt_mop
1 month
Stores information about how the user uses the website such as what pages have been loaded and any other advertisement before visiting the website for the purpose of targeted advertisements.
ouuid
1 year
This cookie is used to store the unique visitor ID which helps in identifying the user on their revisit, to serve retargeted ads to the visitor.
ouuid_lu
1 year
This cookie is used for serving the retargeted ads to the users. This cookie is used in association with the cookie "ouuid".
ov
1 year 1 month
This cookie is set by the provider mookie1.com. This cookie is used for serving the user with relevant content and advertisement.
pxrc
2 months
The purpose of the cookie is to identify a visitor to serve relevant advertisement.
rlas3
1 year
The cookie is set by rlcdn.com. The cookie is used to serve relevant ads to the visitor as well as limit the time the visitor sees an and also measure the effectiveness of the campaign.
rud
1 year 24 days
The domain of this cookie is owned by Rocketfuel. The main purpose of this cookie is advertising. This cookie is used to identify an user by an alphanumeric ID. It register the user data like IP, location, visited website, ads clicked etc with this it optimize the ads display based on user behaviour.
ruds
session
The domain of this cookie is owned by Rocketfuel. This cookie is a session cookie version of the 'rud' cookie. It contain the user ID information. It is used to deliver targeted advertising across the networks.
sa-user-id
1 year
The cookie is set by StackAdapt used for advertisement purposes.
sa-user-id-v2
1 year
The cookie is set by StackAdapt used for advertisement purposes.
smd
1 year 24 days
This domain of this cookie is owned by Rocketfuel. This cookie is used to provide the visitor with relevant content and advertisement.
ssi
1 year
This cookie is set by Sitescout.This cookie is used for marketing and advertising. The cookie stores a unique ID used for identifying the return users device and to provide them with relevant ads.
stx_user_id
1 year
The domain of this cookie is owned by the Sharethrough. This cookie is used for advertising services.
suid_legacy
1 year
This cookie is used to collect information on user preference and interactioin with the website campaign content. This cookie is used for promoting events and products by the webiste owners on CRM-campaign-platform.
test_cookie
15 minutes
This cookie is set by doubleclick.net. The purpose of the cookie is to determine if the user's browser supports cookies.
tidal_ttid
1 year
This cookie is set by Videology. The cookie stores a videology unique identifier. It helps to know whether a visitor has seen the ad and clicked or not.
tluid
3 months
This cookie is set by the provider AdRoll.This cookie is used to identify the visitor and to serve them with relevant ads by collecting user behaviour from multiple websites.
tuuid
1 year
This cookie is set by .bidswitch.net. The cookies stores a unique ID for the purpose of the determining what adverts the users have seen if you have visited any of the advertisers website. The information is used for determining when and how often users will see a certain banner.
tuuid_lu
1 year
This cookie is set by .bidswitch.net. The cookies stores a unique ID for the purpose of the determining what adverts the users have seen if you have visited any of the advertisers website. The information is used for determining when and how often users will see a certain banner.
uid
2 months
This cookie is used to measure the number and behavior of the visitors to the website anonymously. The data includes the number of visits, average duration of the visit on the website, pages visited, etc. for the purpose of better understanding user preferences for targeted advertisments.
uuid
1 year 1 month
To optimize ad relevance by collecting visitor data from multiple websites such as what pages have been loaded.
uuid2
3 months
This cookies is set by AppNexus. The cookies stores information that helps in distinguishing between devices and browsers. This information us used to select advertisements served by the platform and assess the performance of the advertisement and attribute payment for those advertisements.
VISITOR_INFO1_LIVE
5 months 27 days
This cookie is set by Youtube. Used to track the information of the embedded YouTube videos on a website.
wfivefivec
1 year 1 month
The domain of this cookie is owned by Dataxu. The main business activity of this cookie is targeting and advertising. This cookie tracks the advertisement report which helps us to improve the marketing activity.