The Impact of the Government Debt-to-GDP Ratio on Investment Growth

Abstract

Do positive government debt-to-GDP (debt-to-GDP) shocks lead to higher investment growth? Evidence in this chapter shows that real GDP growth, formal non-agriculture employment growth, and investment growth decline in response to positive debt-to-GDP ratio shocks. The results of a decline in employment growth are robust, as we establish that the private and public sector employment growth decline in response to a positive debt-to-GDP ratio shock. Furthermore, persistent positive debt-to-GDP ratio shocks result in a larger and prolonged decline in real GDP growth, formal non-agricultural employment growth, and investment growth. Whereas non-persistent positive debt-to-GDP ratio shocks result in a less pronounced decline in real GDP growth, formal non-agricultural employment growth, and investment growth. At the same time, we find that there are meaningful differences in the responses of real GDP growth, employment growth, and investment growth to shocks in low and high debt-to-GDP regimes. Real GDP growth, formal non-agricultural employment growth, and investment growth increase due to positive debt-to-GDP ratio shocks in the low debt-to-GDP ratio regime. This increase is particularly large and prolonged due to persistent positive debt-to-GDP ratio shocks in the low debt-to-GDP ratio regime compared to non-persistent shocks. The opposite is true with respect to the responses of these variables to positive debt-to-GDP ratio shocks in the low debt-to-GDP ratio regime. The implication of the results is that debt-to-GDP ratio regimes matter for the impact of government debt on the macroeconomy.