Philipp Heimberger – Do higher public debt levels undermine growth?

Philipp recently published a new empirical study on whether higher public debt levels reduce economic growth.

Philipp Heimberger is Economist at the Vienna Institute for International Economic Studies (wiiw)

This interview was originally posted in French in atlantico

Atlantico [AT]: It is usually assumed that high levels of public debt are a drag on growth. However, your study published for the Vienna Institute for International Economic Studies shows that it is not so easy to make a causal link between public debt and lower growth and that the effect is rather null. How do you arrive at this conclusion?  How do you explain this?

Philipp Heimberger [PH]: My study provides a quantitative analysis of whole empirical literature on the impact of public debt levels on economic growth; that’s more than 800 estimates from about 50 studies. Once you properly summarise this literature and correct for publication bias in favour of negative growth effects, there are two main findings: first, the average linear effect of public debt levels on growth is zero. Second, there is no evidence for uniform thresholds in the public-debt-to-GDP ratio in all countries beyond which growth falls.

This finding is quite plausible, since there are no strong reasons why there should be “magic“ threshold in the public debt level beyond which growth slows. The well-known researchers Reinhart and Rogoff claimed this in a famous paper in 2010, and policy-makers used this to argue in favour of spending cuts to bring down public debt. But it was always a chimera – unfortunately a very costly one, since this kind of reasoning has promoted a “one-size-fits-all” austerity approach that has wreaked havoc on the Eurozone.

AT: If public debt is not responsible for a drop in growth, what is the concrete impact of this debt on the economy of a country?

PH: My study is about the impact of public debt levels on growth. Think about it this way: does it matter for growth going forward if country A in the initial period had a public-debt-to-GDP ratio of 110%, while country B had a ratio of just 60%. My findings suggest that the effects on growth are, on average, close to zero. Governments may still be confronted with country-specific unsustainable debt levels, in particular if interest payments increase strongly. With higher public debt levels, the risk of being pushed into a bad situation with panic-induced bond sell-offs by financial market investors is higher – especially in the Eurozone, when there are doubts about whether the ECB will backstop government bond markets. However, this would suggest that a government’s ability and willingness to use fiscal policy properly depends more on the monetary arrangements and on public debt structures than on the actual level of the public-debt-to-GDP ratio.

The results in my study suggest that – given the further increase in public-debt-to-GDP ratios against the background of the Covid-19 crisis in most countries – there is no evidence for a general urgency to bring down public debt levels to avoid a drag on growth. A cautious reading of the existing evidence calls for caution when it comes to “one-size-fits-all” fiscal policy prescriptions in response to high public-debt-to-GDP ratios such as the simultaneous drive towards fiscal consolidation in Europe from 2010 onwards.

AT: In view of these results, does it make sense to try to reduce public debt at all costs to boost the economy, for example in a health crisis? 

PH: No, going for a reduction of public debt levels “at all costs” would actually backfire, as we have learned during the Euro Crisis. Back then, there was the dominant argument that public debt levels are too high and would act as a drag on growth; and that this should mainly be addressed by cutting government spending. However, this strategy choked the economic recovery in several Eurozone countries, and thereby made it more difficult for countries to grow out of their higher, crisis-induced public debt levels. An excessive focus on bringing down public debt levels can be counterproductive. European policy-makers should strive to learn from this after the Covid-19 crisis, and avoid the mistakes from the recent past.

AT: Does this mean that all forms of debt control or austerity measures should be stopped?

PH: Public debt sustainability should still remain one of several important goals of fiscal policy. But my results suggest that past concerns about higher public debt levels as a drag on growth have been exaggerated.

Policy-makers should recognise that the economic policy strategy needs to be more balanced than the strategy pursued during the Euro Crisis: we need to make sure that the recovery from the Covid-19 crisis can continue over the next quarters and years, and that unemployment rates can decline towards full employment; fiscal policy needs to support this, for example by promoting public investment with positive long-run growth effects. A vibrant economy with a well-functioning labour market is essential for long-run public debt sustainability. This idea that we just need to control the public debt level to succeed in bringing about stronger growth and debt sustainability is flawed. My study is one piece of the larger empirical puzzle suggesting that we should critically assess our public-debt-to-GDP fixations of the past.

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