Public Debt of 80%-100% of GDP Hurts Growth, BIS Economists Say

Governments begin to hobble economic growth when public debt runs as high as 80 percent to 100 percent of gross domestic product, according to a study by economists at the Bank for International Settlements.

An increase in debt to around that range may impose a “significant impact” on economic performance, Basel, Switzerland-based economists led by Stephen Cecchetti estimated after studying three decades of data from 18 industrial nations. A 10 percentage point increase in the debt-to-GDP ratio reduces an economy’s non-inflationary growth rate by as much as 15 basis points, they said.

The findings were presented at today’s meeting of global central bankers in Jackson Hole, Wyoming, and come as investors signal concern that rising public debt leaves governments unable to fight renewed recession risks. International Monetary Fund data suggest government gross debt levels will top 80 percent of GDP in each of the Group of Seven advanced economies this year.

“Our reports support the view that, beyond a certain level, debt is bad for growth,” wrote Cecchetti, head of the BIS’s monetary and economic department, and colleagues M.S. Mohanty and Fabrizio Zampolli.

Standard & Poor’s downgraded the U.S. government’s credit rating this month, while Europe’s sovereign debt crisis is threatening to engulf Spain, Italy and perhaps even France. Adjusting for inflation, government debt in advanced economies has risen about 4.25 times since 1980, the BIS economists said.

‘Retard Growth’

“Our result for public debt has the immediate implication that highly indebted governments should aim not only at stabilizing their debt but also at reducing it to sufficiently low levels that do not retard growth,” the economists said.

Stabilization of debt may nevertheless not be enough because nations also face a period where debt dynamics worsen as populations age, increasing pension and health care costs, they said.

Corporate debt beyond 90 percent of GDP and household debt above 85 percent can also drag on growth, the economists said. They found that the ratio of debt in rich nations has risen from 165 percent in 1980 to 310 percent today, an average of more than 5 percentage points of GDP per year. Government, corporate and household debt each account for about a third of the gain.

For corporate debt, a one percentage point increase causes a 2 basis point reduction in per capita GDP growth, while the same rise in household debt knocks 2.5 basis points off growth, the study said. They also found that for every year spent in a banking crisis, average growth falls by an average of 27 basis points in the subsequent five years.

“At low levels, debt is good,” wrote Cecchetti, Mohanty, Zampolli. “It is a source of economic growth and stability. But at high levels, private and public debt are bad, increasing volatility and retarding growth.”

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