Debt and growth
Breaking the threshold
New research suggests debt’s trajectory affects growth more than its level
Mar 1st 2014
CAN countries imperil their growth prospects by having too much debt? In 2010 Carmen Reinhart and Kenneth Rogoff of Harvard University argued that countries experience a sharp slowdown in growth when their public debt-to-GDP ratios hit 90%. Not everyone was convinced. Then in 2013 three economists at University of Massachusetts Amherst found that spreadsheet errors had skewed their results.
A new IMF paper now poses a more substantial challenge to Ms Reinhart and Mr Rogoff’s thesis. Using data for debt and growth from 1821 to 2012, the authors found that growth in GDP per head is slower in countries with a debt-to-GDP ratio above 90% when looking at the data year-by-year (see chart). But many of these slowdowns were produced by factors unrelated to debt levels. For instance, the growth figures for countries with debts of more than 135% of GDP are depressed mainly because the debt-laden Japanese and German economies collapsed in 1945.
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If one looks at average debt levels over 15-year periods instead, there is no evidence that countries with debt of above 80% of GDP grow more slowly (see chart). Even countries with debt ratios of more than 200%, such as post-war Britain, experienced solid medium-term growth. More important than absolute levels of debt may be their trajectory. Countries with rising public-debt ratios suffer slower growth than those where it is falling—even if their accrued borrowings are already very high. This may be because budget deficits make them more vulnerable to economic instability.
Recent research indicates that rising private-debt levels also endanger growth. A paper by Moritz Schularick, now at the University of Bonn, and Alan Taylor, at the University of Virginia, has found that rapid total credit growth was the best predictor of financial crisis from 1870 to 2008. That should provide reassurance in the embattled euro area, where public and private-sector debt levels stabilised in 2013.
China, however, has seen its total credit-to-GDP ratio leap 95 percentage points since 2007. Be warned: debt splurges, of either sort, can easily cause a bad hangover.
A new IMF paper now poses a more substantial challenge to Ms Reinhart and Mr Rogoff’s thesis. Using data for debt and growth from 1821 to 2012, the authors found that growth in GDP per head is slower in countries with a debt-to-GDP ratio above 90% when looking at the data year-by-year (see chart). But many of these slowdowns were produced by factors unrelated to debt levels. For instance, the growth figures for countries with debts of more than 135% of GDP are depressed mainly because the debt-laden Japanese and German economies collapsed in 1945.
If one looks at average debt levels over 15-year periods instead, there is no evidence that countries with debt of above 80% of GDP grow more slowly (see chart). Even countries with debt ratios of more than 200%, such as post-war Britain, experienced solid medium-term growth. More important than absolute levels of debt may be their trajectory. Countries with rising public-debt ratios suffer slower growth than those where it is falling—even if their accrued borrowings are already very high. This may be because budget deficits make them more vulnerable to economic instability.
Recent research indicates that rising private-debt levels also endanger growth. A paper by Moritz Schularick, now at the University of Bonn, and Alan Taylor, at the University of Virginia, has found that rapid total credit growth was the best predictor of financial crisis from 1870 to 2008. That should provide reassurance in the embattled euro area, where public and private-sector debt levels stabilised in 2013.
China, however, has seen its total credit-to-GDP ratio leap 95 percentage points since 2007. Be warned: debt splurges, of either sort, can easily cause a bad hangover.
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