ECONOMIC GROWTH AND PUBLIC DEBT: ADDRESSING UNOBSERVED HETEROGENEITY
The article addresses the non linear and heterogeneous relationship between public debt and economic growth considering the recent combination of increasing public expenditures and debt with continuing low economic growth observed in many countries, controlling the results by an institutional quality multidimensional indicator. Economic theory generally supports a negative relationship between debt and growth in the long run, whereas in the short run fiscal stimulus may induce positive effects. Empirical literature provides some evidence for both, showing that the negative relationship might become more important after reaching a certain threshold, but the results are not absolutely conclusive. Problems of unobserved heterogeneity might be a major reason for that. To tackle the problem of unobserved heterogeneity we suggest a two stage procedure applied to a large sample of 154 countries. We first use cluster analysis to group the countries by their governance quality using the Worldwide Governance Indicators (WGI) database. In a second step the relationship between public debt and growth is investigated using simple and threshold multiple panel regression models (TMR) The results confirm the coefficients to be negative in the long run and to vary across country groups (clusters) depending on institutional quality. JEL Classification Code: O47, E62, C24, F34, H63