Public debt and economic growth nexus in the Euro area: A dynamic panel ARDL approach

Abstract

This study investigates the relationship between public debt and economic growth using panel data from 10 European countries. Using a panel ARDL approach, the results show that public debt, government consumption, and the real exchange rate are negatively associated with economic growth in both the short and the long run. Furthermore, investment and the real interest rate were found to be positively associated with economic growth in both the short and the long run. Inflation and trade openness were found to have mixed results: both were negatively associated with economic growth in the long run while in the short run the relationship was positive and consistent across groups with a few exceptions. Second, the study results also showed that debt is nonlinear at the 70% threshold only in the long run, while in the short run the results were consistently negative and across groups. The study results have significant policy implications for the Stability and Growth Pact of the Euro area. It is recommended that member states should ensure fiscal sustainability by balancing their fiscal budgets to effectively reduce the accumulation of public debt as well as implementing structural reforms that will improve the efficiency of investment as well as macroeconomic stability.