Threshold Effects in Debt-Growth Relationships

Following the 1980s debt crisis a consensus has emerged that there is a debt threshold in the debt-growth relationship. This paper estimates the debt threshold empirically using endogenous threshold model proposed by Hansen (1996, 2000) and several other modelling strategies to check the robustness of the findings. The following results emerge: (i) the optimal debt is different for different model specifications and across different estimators; (ii) the quadratic model predicts that debt threshold occurs between 24%-46% debt-to-GDP ratio; (iii) Hansen’s threshold model suggests that debt becomes detrimental to growth when debt-to-GDP ratio approaches 45%.