The Economic Ripple: How Government Debt Influences Growth

Abstract

This analysis looks at the impact of government debt on economic growth by relying on recent research and new findings. Using information from 10 developing nations, we estimate a regression (PSTR) where the effect of public debt on GDP growth changes only after reaching a certain level of debt. We used government spending, investment, industry and services employment and trade openness indicators from the World Bank. Because of the results from unit-root tests, correlation checks and linearity tests, we are using our method. The major result is that debt and growth follow an inverted U-shape. For debt below 60% of GDP, a rise in debt is linked to slightly more growth, but once the debt-GDP ratio is above 61%, it tends to reduce growth. The result is consistent with recent research that shows turning points occurring at around 50–65%. Moderate spending and increased investment help boost growth, but they are less effective when the public debt is high, perhaps due to crowding out and a decline in how efficiently resources are used. These results do not change when using different methods. All in all, our findings suggest that handling debt wisely is necessary: using some debt to finance infrastructure and social programs can help economic growth, but after a certain limit, it no longer does. Therefore, policymakers should prevent large deficits and maintain moderate debt to encourage economic growth.