Friday, July 20, 2012
Two Economic Papers Really Worth Reading
Against the background of the euro area sovereign debt crisis, our paper investigates the relationship between public debt and economic growth and adds to the existing literature in the following ways. First, we extend the threshold panel methodology by Hansen (1999) to a dynamic setting in order to analyse the nonlinear impact of public debt on GDP growth. Second, we focus on 12 euro area countries for the period 1990-2010, therefore adding to the current discussion on debt sustainability in the euro area. Our empirical results suggest that the shortrun impact of debt on GDP growth is positive and highly statistically signi cant, but decreases to around zero and loses signi cance beyond public debt-to-GDP ratios of around 67%. This result is robust throughout most of our speci cations, in the dynamic and non-dynamic threshold models alike. For high debt-to-GDP ratios (above 95%), additional debt has a negative impact on economic activity. Furthermore, we can show that the long-term interest rate is subject to increased pressure when the public debt-to-GDP ratio is above 70%, broadly supporting the above findings.
We seek to understand how La ffer curves diff er across countries in the US and the EU-14, thereby providing insights into fi scal limits for government spending and the service of sovereign debt. As an application, we analyze the consequences for the permanent sustainability of current debt levels, when interest rates are permanently increased e.g. due to default fears. We build on the analysis in Trabandt and Uhlig (2011) and extend it in several ways. To obtain a better fi t to the data, we allow for monopolistic competition as well as partial taxation of pure pro fit income. We update the sample to 2010, thereby including recent increases in government spending and their scal consequences. We provide new tax rate data. We conduct an analysis for the pessimistic case that the recent fi scal shifts are permanent. We include a cross-country analysis on consumption taxes as well as a more detailed investigation of the inclusion of human capital considerations for labor taxation.
Intuitively, higher labor taxes lead to a faster reduction of the labor tax base since households work less and aquire less human capital which in turn leads to lower labor income. We recalculate the implied maximum interest rates on government debt in 2010 when human capital accumulation is allowed for in the model. Table 9 contains the results: the US may only a fford a real interest rate between 5.8% to 6.6% in this case. Most of the European countries cluster between 4% and 4.9% except for Denmark, Finland and Ireland who can aff ord real interest rates between 5.9% and 9.5%.
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