The financial
crisis of 2008, which was rapidly transformed into a sovereign debt crisis for
several European economies revived the academic and policy discussion about the
effects of the public debt on the economic growth.

In the past, the
problem of high public debt was mainly associated with developing regions of
the world. However, during the last decade and as a consequence of the recent
crisis, the level of public debt is one of the most discussed subjects in the
western world and mainly in the European Union. It is widely known that during
the last years the public debt to GDP ratio of many countries of the western
world has rapidly increased leading not only to a crisis of confidence for the European
economies but also to a huge economic and political crisis, which brought into
question even the existence of the Eurozone and the European Union. According
to Eurostat, the statistical office of the European Union, the government debt
to GDP ratio in the Euro area (EA19) stands at 90.1%, At the end of 2016,
sixteen member states had government debt ratios higher than 60% of GDP, with
the highest registered in Greece (179.0%), Italy (132.6%), Portugal (130.4%),
Cyprus (107.8%) and Belgium (105.9%). 

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As a result of the
debt crisis, several European countries in order to avoid sovereign default, had
to make significant fiscal adjustment efforts and implement austerity
government measures in a short period of time that aimed to demonstrate fiscal
discipline, restore market confidence and fiscal sustainability. However, there
seems to be a lack of consensus on whether or not high public debt and debt
sustainability affects negatively the economic growth. Consequently, the debate
on the economic necessity to drastically reduce public debt and cut budgetary
deficits is still open.

There are three
economic school of thoughts which try to answer whether the rising public debt
slows down the pace of economic growth or not. According to the neoclassical
school, the influence of debt to economic growth is negative. However, based on
the Keynesian approach the effect of increasing public debt can be positive
during an economic recession. In contrast with the other theories the Ricardian
view supports that the influence of debt to growth is neutral or irrelevant.
During the last decades, several empirical studies have found evidence that
support the negative relationship between debt and growth. However, only during
the last years the researchers tried to examine directly the effect of debt on
growth of western developed countries in the European continent. This paper
will follow this line and will focus on the developed European countries
members of the OECD.

The lack of consensus in the economic literature about the effects of
debt on the economic growth and the existence of a specific level at the ratio
of the public debt to GDP above which the rising debt slows down the pace of
economic growth are the main academic motivators to conduct this research.
During the last years there have been mixed results from the empirical studies
whether there is a systematic relationship between public debt and economic
growth for the developed economies. Moreover, according to the findings of
recent empirical studies the impact of the debt thresholds to the growth, depend
on the macroeconomic framework and can be biased if they fail to take into
account the macroeconomic conditions. As a result, they claim that the debt
threshold analysis is not a sufficient enough predictor of the growth by and state
that the debt sustainability should be considered as an additional predictor of
the economic growth.

This proposed study attempts to take part in the, until now
inconclusive, debate whether there is a systematic relationship between public
debt and economic growth. An another
questions that tries to examine is the existence of a specific level in the
level of government debt, above which the GDP growth is drastically
compromised. More precisely, it tries to investigate if a public debt to GDP
ratio which exceeds the threshold of 60% that has been set by the Maastricht
criteria is deleterious for growth is Moreover, it attempts to unify and extend
the two different types of researches mentioned above, by examining both the
impact of debt non-linearities and debt sustainability on the economic growth
of 18 European countries during the period of 1991 to 2016. Additionally, this
study tries to examine whether or not the participation in the Euro area contains
an extra risk for its members. Lastly, it examines if the relationship between
public debt and economic growth has changed after the financial crisis of 2008.

The results of this study will be useful to the academic community and
the policy makers since it will shed light to relationship of public debt and
economic growth, a relationship which plays an important role in the design of
the implemented fiscal policies in Europe. Moreover, the results that will be
provided by this research can be compared with previous papers on this topic
and will improve the generalizability of the theory about the impact of public
debt on growth.

Summarizing, the main problem statement for this study is:

              “Is there a systematic
relationship between public debt and economic growth?”

Several sub-questions are generated by the central problem statement:

– What is the role of the 60% threshold set by the Maastricht criteria on
economic growth?

– What is the role of (non-) sustainable debt to GDP ratio on economic growth?

– Is it possible to detect a di?erence among Euro members and non–Euro
members?

– Has the relationship between public debt and economic growth changed after
the financial crisis of 2008?

– Do the past
findings of other papers on this topic, still hold in the Euro area setting?

Results

The remaining of
the study is structured as follows. The next section presents the literature
review of the main theoretical and empirical research papers that have examined
the relationship of the public debt with the economic growth. Section three
presents the dataset I have used to conduct my research, a preliminary data analysis
and estimation results. Section four discusses the methodology employed,
provides further stylized facts and presents graphical impressions of the
series. Section five presents the empirical analysis. Section six concludes.