Growth, Debt, and Inequality

Abstract

After the 2009 global recession, many papers identified a non-linear inverted Ushaped relationship between economic growth and sovereign debt. However, their results are mixed regarding the exact turning point. According to the traditional view, we assume debt-to-growth causality and show that the mixed results depend on the heterogeneity of the non-linear debt-growth relationship. In our sample of 27 countries over the period 1994-2010, countries with a higher Gini index, our measure of income inequality, show lower threshold points upon which further increases in debt reduce growth, but a higher sensitivity of growth to debt changes. Hence, the more even the income distribution, the more a country should be fiscally virtuous to avoid affecting growth. The implication is that policies promoting a more equal income distribution reduce (increase) economic growth in (not) highly indebted countries.