Public debt and aggregate investment in the EU

ABSTRACT

In this paper, I study the public debt-aggregate investment nexus in a panel of EU countries. The empirical approach is based on the common factor framework, which allows accounting for cross-country heterogeneity and cross-sectional dependence. The empirical results indicate that public debt has, on average, an adverse effect that is more pronounced in the public investment case. Moreover, there are evidence indicating the presence of a nonlinear relationship between debt and investment.

KEYWORDS:

• Common factor model
• cross-sectional dependence
• non-linearity
• public debt

JEL CLASSIFICATION:

• E22
• E62
• C23
• H63

Acknowledgments

I would like to thank Apostolos Fasianos, Kieran McQuinn, Conor O’Toole and Petros Varthalitis for their comments and suggestions in earlier versions of this paper.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

¹ Admittedly, there are a number of potential drivers of investment that could be considered. However, the relatively small T dimension of the panel necessitates the use of a parsimonious specification; moreover, due to data limitations (e.g. data for long-term interest rates are available for all EU countries only post-2000), I opted for a commonly used control variable, for which observations for all countries are available for the period covered.