RUHR. It s the Debt-Growth Nexus Again ECONOMIC PAPERS. Evidence from a Long Panel of Regional-Government Liabilities #406. Timo Mitze Florian Matz

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1 RUHR ECONOMIC PAPERS Timo Mitze Florian Matz It s the Debt-Growth Nexus Again Evidence from a Long Panel of Regional-Government Liabilities #406

2 Imprint Ruhr Economic Papers Published by Ruhr-Universität Bochum (RUB), Department of Economics Universitätsstr. 150, Bochum, Germany Technische Universität Dortmund, Department of Economic and Social Sciences Vogelpothsweg 87, Dortmund, Germany Universität Duisburg-Essen, Department of Economics Universitätsstr. 12, Essen, Germany Rheinisch-Westfälisches Institut für Wirtschaftsforschung (RWI) Hohenzollernstr. 1-3, Essen, Germany Editors Prof. Dr. Thomas K. Bauer RUB, Department of Economics, Empirical Economics Phone: +49 (0) 234/ , Prof. Dr. Wolfgang Leininger Technische Universität Dortmund, Department of Economic and Social Sciences Economics Microeconomics Phone: +49 (0) 231/ , Prof. Dr. Volker Clausen University of Duisburg-Essen, Department of Economics International Economics Phone: +49 (0) 201/ , Prof. Dr. Christoph M. Schmidt RWI, Phone: +49 (0) 201/ , Editorial Offi ce Joachim Schmidt RWI, Phone: +49 (0) 201/ , Ruhr Economic Papers #406 Responsible Editor: Prof. Dr. Christoph M. Schmidt All rights reserved. Bochum, Dortmund, Duisburg, Essen, Germany, 2013 ISSN (online) ISBN The working papers published in the Series constitute work in progress circulated to stimulate discussion and critical comments. Views expressed represent exclusively the authors own opinions and do not necessarily reflect those of the editors.

Universitätsstr. 12, 45117 Essen, Germany Rheinisch-Westfälisches Institut für Wirtschaftsforschung (RWI) Hohenzollernstr. 1-3, 45128 Essen, Germany Editors Prof. Dr. Thomas K.

3 Ruhr Economic Papers #406 Timo Mitze and Florian Matz It s the Debt-Growth Nexus Again Evidence from a Long Panel of Regional-Government Liabilities

4 Bibliografische Informationen der Deutschen Nationalbibliothek Die Deutsche Bibliothek verzeichnet diese Publikation in der deutschen Nationalbibliografie; detaillierte bibliografische Daten sind im Internet über: abrufbar. ISSN (online) ISBN

detaillierte bibliografische Daten sind im Internet über: http://dnb.d-nb.

5 Timo Mitze and Florian Matz 1 It s the Debt-Growth Nexus Again Evidence from a Long Panel of Regional- Government Liabilities Abstract In this paper, we study the long- and short-run relationship between regional public debt and economic performance for a sample of German federal states over the period of four decades ( ). By choosing a sample of regional entities with comparable institutional settings, we complement the large literature on the debt-growth nexus based on heterogeneous cross-country samples. We estimate a dynamic error correction model that accounts for slope heterogeneity among cross-sections and the presence of unobserved common factors. While in line with the Keynesian view our findings hint at a non-linear inverted U-shape relationship between changes in the public debt intensity and economic growth in the short-run, we get strong statistical evidence for linear negative relationship between regional public depth and per capita GDP in the long-run. By means of a simple though experiment, we show that these negative longrun effects are not negligible for the size of interregional differences in per capita GDP levels and are in line with most international evidence on the detrimental growth effects of high public debt levels. Finally, these results also underline the need for effective fiscal rules at the federal state level in Germany. JEL Classification: C23, R11, R50, E62 Keywords: Government debt; economic growth; German states; panel data; unobserved common factors March Timo Mitze, University of Southern Denmark, RWI, and RCEA; Florian Matz, RWI. The authors acknowledge valuable comments from Torben Dall Schmidt and Christoph M. Schmidt. We are also grateful to Markus Eberhardt for helpful comments on the implementation of common correlated effects estimators in STATA. All correspondence to Timo Mitze, University of Southern Denmark, Alsion 2, 6400 Sønderborg, Denmark, tmitze@sam.sdu.dk.

By choosing a sample of regional entities with comparable institutional settings, we complement the large literature on the debt-growth nexus based on heterogeneous cross-country samples.

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