How High Government Debt Destroys GDP Growth

Posted on 26/08/2010


Cristina Checherita and Philipp Rother of the ECB have recently published an empirical study looking at the effect of high government debt on GDP growth, snappily entitled “The Impact of High and Growing Government Debt on Economic Growth: An Empirical Investigation for the Euro Area“, in which they find that:

“This means that, on average for the 12-euro area countries, government debt-to-GDP ratios above such threshold [90-100% of GDP] would have a negative effect on economic growth.  Confidence intervals for the debt turning point suggest that the negative growth effect of high debt may start already from levels of around 70-80% of GDP, which calls for even more prudent indebtedness policies.  The channels through which government debt (level or change) is found to have an impact on the economic growth rate are: (i) private saving; (ii) public investment; (iii) total factor productivity (TFP) and (iv) sovereign long-term nominal and real interest rates.  From a policy perspective, a negative impact of public debt on economic growth strengthens the arguments for ambitious debt reduction through fiscal consolidation.

Given that UK debt-to-GDP is forecast by the government to reach 70% (see chart, below) – and that is using their own optimistic GDP growth projections which assume dramatic export and investment growth – the analysis supports the thesis that those politicians and commentators arguing for more expansionary fiscal policies would risk  driving the UK towards a Greek-style situation of high debt and no growth.