No Magic Threshold

• Author: Andrea Pescatori, Damiano Sandri, and John Simon
• Position: and are Economts in the IMF's Research Department. is a former Senior Economist in the IMF's Research Department who is now Deputy Head of Research at the Reserve Bank of Australia.

ECONOMISTS have debated whether there is a threshold in the level of government debt to GDP above which a nation’s medium-term economic growth prospects are dramatically compromised. Whether there is such a tipping point is of critical importance not just because of the historically high level of public debt in many advanced economies, but also because of its implications for debt accumulation in all economies. If there is a level above which debt substantially lowers growth, then reducing debt below that threshold should be a high priority. On the other hand, if there is no point at which growth prospects start to decline dramatically, then policymakers may find it appropriate to give priority to increasing growth rather than reducing debt ratios.

There is no agreement on the issue among researchers. Influential papers such as Reinhart and Rogoff (2010) and Reinhart, Reinhart, and Rogoff (2012) argue that there is a threshold effect: when debt in advanced economies exceeds 90 percent of GDP there is an associated dramatic worsening of growth outcomes. Others dispute the notion that there is such a clear threshold and suggest that it is weak growth that causes high debt rather than high debt that causes weak growth (Panizza and Presbitero, 2012; Herndon, Ash, and Pollin, 2013). Using a new approach we found little evidence that there is any particular debt ratio above which growth falls sharply.

A new approach

The fresh approach we took utilizes a new and comprehensive IMF database on gross government-debt-to-GDP ratios, interest payments, and primary deficits that covers nearly all the 188 IMF members—for many of them from 1875 to 2011 (Abbas and others, 2010, 2011). We augmented the IMF data with real GDP data from Maddison (2003) and other data from Reinhart and Rogoff (2010). We focused on 34 advanced economies, reflecting the availability and coverage of the supplementary data. The average debt-to-GDP ratio in the 34-country sample was 55 percent, while the average real output per capita growth rate was 2¼ percent a year. Given that the sample encompasses two world wars and the Great Depression there is rich historical experience, but it also includes many unique circumstances that need to be borne in mind when analyzing the results.

We considered all episodes in which gross public debt rose above a certain threshold (we used a number of them) and looked at the real GDP growth per capita over the subsequent 1, 5, 10, and 15 years. An important difference in our methodology from that of Reinhart and Rogoff’s 2010 paper is that we focus on the medium- to long-term relationship between today’s stock of debt to GDP and subsequent GDP growth rather than on just the short-term relationship. The longer-term perspective should mitigate the confounding effects that temporary recessions or bursts of growth can have on the relationship between debt and growth in the short run.

Reinhart, Reinhart, and Rogoff (2012) used a longer-term methodology, but our approach also differs from theirs in two additional important aspects:

• We considered a broad range of debt thresholds, not just 90 percent.

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