Board of Governors of the Federal Reserve System

December 2012

Government Debt and Macroeconomic Activity: A Predictive Analysis for Advanced Economies

Deniz Baglan and Emre Yoldas

Abstract:

This paper explores the empirical relationship between government debt and future macroeconomic activity using data on twenty advanced economies throughout the post-war era. We use robust inference techniques to deal with the bias arising from the persistent nature of debt to GDP ratio as an endogenous predictor of GDP growth. Our results show that statistical significance of the coefficient on the debt ratio in predictive regressions changes considerably with the use of robust inference techniques. For countries with relatively low average debt ratios we find a negative threshold effect as their debt ratios increase toward moderate levels. For countries with chronically high debt ratios, GDP growth slows as relative government debt increases, but we find no significant threshold effect.

Keywords: Government debt, GDP growth, near unit-root process, threshold, subsampling, threshold, subsampling

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