Tuesday, December 31, 2013

31/12/2013: Debt and Growth: Consumption Crowding-Out Channel

Since the overhyped and outright hysterical 'controversy' over the Reinhart & Rogoff debt thesis blew up across the media earlier this year (I covered much of the controversy on the blog and in my columns, for example, here http://trueeconomics.blogspot.ie/2013/07/272013-village-june-2013-real-effects.html), it became - to put it mildly - unfashionable to reference the adverse effects of debt on growth and economy. Too bad, some economists seem to have missed that point.

A new study from the Korea Institute for International Economic Policy, titled "Nonlinear Effects of Government Debt on Private Consumption in OECD Countries" (see citation below) looked at "nonlinear effects of government debt on private consumption in 16 OECD countries. The estimated consumption function shows smooth regime switching depending on the debt-to-GDP ratio, and the threshold level of regime switching is found to be the ratio of 83.7 percent. The results reveal that a higher level of government debt crowds out private consumption to a greater extent, and that the degree of the crowding out effect has deteriorated since the global financial crisis."

Wait, there are thresholds here… 83.7% debt/GDP ratio - very close to the  S. Cecchetti, M. Mohanty and F. Zampolli thresholds (see http://trueeconomics.blogspot.ie/2011/09/26092011-irelands-debt-overhang.html). And there is the 'causal link' between debt and growth via crowding out of private consumption.

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