It's the Debt Growth Nexus Again Evidence from a Long Panel of Regional Government Liabilities
In this paper, we study the long and short run relationship between regional public debt and economic performance for a sample of German federal states over the period of four decades (1970 2010) By choosing a sample of regional entities with comparable institutional settings, we complement the large literature on the debt growth nexus based on heterogeneous cross country samples. We estimate a dynamic error correction model that accounts for slope heterogeneity among cross sections and the presence of unobserved common factors. While in line with the Keynesian view our findings hint at a non linear inverted U shape relationship between changes in the public debt intensity and economic growth in the short run, we get strong statistical evidence for linear negative relationship between regional public depth and per capita GDP in the long run. By means of a simple though experiment, we show that these negative longrun effects are not negligible for the size of interregional differences in per capita GDP levels and are in line with most international evidence on the detrimental growth effects of high public debt levels. Finally, these results also underline the need for effective fiscal rules at the federal state level in Germany.