The Relationship Between Debt and Output


We empirically investigate the dynamic relationship between debt and output in a panel of 72 countries over the period 1970–2014 using a vector autoregression. We document two puzzling empirical findings that contrast with what is predicted by a standard small open economy model by Aguiar and Gopinath (J Polit Econ 115(1):69–102, 2007), where debt and output endogenously respond to total factor productivity shocks. First, developing countries’ debt falls after a positive output shock, while the model predicts a debt expansion. Second, output declines in developed and developing countries after a debt shock, while the model predicts higher output. The relationship between debt and output depends on the sector taking on debt (households, firms, or governments) and the source of financing (domestic versus external) and differs across countries with varying degrees of economic development or different exchange rate regimes.

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  1. 1.

    This finding inspired extensive follow-up studies that provide mixed results. Cecchetti et al. (2011), Padoan et al. (2012), Cecherita-Westphal and Rother (2012), and Baum et al. (2013) confirmed this finding for similar sets of countries. Nevertheless, Caner et al. (2010), Elmeskov and Sutherland (2012), Baglan and Yoldas (2016), Eberhardt and Presbitero (2015), Herndon et al. (2013), Pescatori et al. (2014), and Egert (2015) showed that finding a negative nonlinear relationship is extremely difficult and sensitive to modeling choices and data coverage.

  2. 2.

    The price of debt takes the form used in Schmitt-Grohe and Uribe (2003):

    $$\begin{aligned} 1/q = 1 + r^{\star } + \psi \left[ \exp \left( b^\prime -b\right) -1\right] , \end{aligned}$$

    where \(r^\star\) is the world interest rate, b is the steady-state level of debt, and \(\psi\) captures the elasticity of the interest rate to changes in debt levels. In choosing \(b^\prime\), the representative agent does not internalize the upward-sloping supply schedule. This feature is introduced to make assets in the linearized model stationary. Quantitatively, \(\psi\) is set close to zero so that the short-run responses are unaffected by this schedule.

  3. 3.

    The list of countries is described in Appendix, Table 3.

  4. 4.

    GDP growth is measured by the percent change in log real GDP. Changes in debt ratios are measured by the percentage-point difference in debt/GDP ratios.

  5. 5.

    The results are not sensitive to the choice of the lag order or to the ordering of the variables.

  6. 6.

    Examples of research on the investment channel include Bernanke and Gertler (1989), Kiyotaki and Moore (1997), Caballero and Krishnamurthy (2003), Lorenzoni (2008), and Brunnermeier and Sannikov (2014). Mian et al. (2013) provide empirical support for this channel for the USA during the Great Recession.

  7. 7.

    The other impulse responses are similar to the full sample case, and thus not reported.

  8. 8.

    The debt responses to a positive output shock and output responses to the other debt expansions are similar across emerging markets and other developing countries, and thus not reported.


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The views expressed here are those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of Chicago or the Federal Reserve System. We thank Gadi Barlevy, Luojia Hu, Aart Kraay, and participants of the 20th Jacques Polak Annual Research Conference for useful discussions and comments. We also thank Erin Gibson for excellent research assistance.

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Correspondence to Jing Zhang.

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A1. Country Coverage

Table 3 List of sample countries

The sample countries are selected by the following procedure. Among the countries with debt data available, we exclude the top and bottom 1% outliers based on the annual changes in debt-to-GDP ratios. Then, we remove countries with the coverage of private and public debt data less than ten consecutive years within our sample period 1970–2014. This leaves us 72 sample countries. We include 21 advanced OECD countries in the developed sample. The rest are included in the developing sample. Among the OECD countries, Chile, Czech Republic, Estonia, Hungary, Israel, Korea, Latvia, Lithuania, Poland, Slovak Republic, Slovenia, and Turkey are kept in the developing sample to be consistent with the developing countries used in the literature. Table 3 shows the list of the sample countries.

A2. Data Sources

National Accounts National accounts data come from the World Bank’s World Development Indicators. For output, we use annual data in constant 2010 US dollars for GDP. For consumption and investment, we use household and NIPSH final consumption expenditure, and gross fixed capital formation, respectively.

Exchange Rate Regime Information about the de facto exchange rate regime comes from Reinhart and Rogoff (2004), which was updated in Ilzetzki et al. (2017). “Fixed regimes” are regimes with no separate legal tender, currency boards, pegs, and narrowly defined horizontal bands (coarse ERA code 1 from Ilzetzki et al. 2017). “Floating regimes” are regimes with widely defined horizontal bands, crawling pegs, crawling bands, moving bands, managed floats, and freely floating regimes (coarse ERA codes 2 to 4).

Private Debt Private debt data come from the private debt, loans and securities series in the IMF’s Global Debt Database. It is defined as total stock of loans and debt securities issued by households and non-financial corporations as a share of lagged GDP.

Public Debt Public debt data come from the IMF’s Historical Public Debt Database. Public debt is gross government debt as a share of lagged GDP.

Foreign Debt Foreign debt data come from the 2016 update of the External Wealth of Nations Mark II database of Lane and Milesi-Ferretti (2007). Net foreign debt is defined as total external liabilities minus total external assets as a share of lagged GDP.

A.3 Robustness Checks

This appendix reports the results for robustness checks. First, we check whether our results are driven by the Great Recession. Specifically, we limit the sample periods up to 2006 and redo the VAR analysis. The results in the pre-global recession sample are similar to those in the baseline full sample, even though the responses often become statistically not significant because of wide confidence bands in the reduced sample. Figure 11 displays the response of output to positive shocks in private debt and public debt as an illustration.Footnote 7 In the full sample, private debt negatively impacts output in both developed and developing countries. In the pre-global recession sample, the negative impact of private debt is much weaker and statistically not significant. The result for public debt we observe in the full sample still remains in the pre-global recession sample as well. A positive public debt shock reduces output in developed countries and raises output in developing countries.

Fig. 11

Impulse responses: pre-Great Recession. Notes: The figure presents impulse responses from a three-variable VAR in log real GDP, the ratio of public debt to GDP, and the ratio of private debt to GDP. The solid lines are the responses to a one-percent shock in each variable, and the dashed lines are 95% confidence intervals computed with the bias-corrected bootstrap

Second, given the large heterogeneity across the developing countries, we separate the developing sample further into two groups: emerging markets and other developing countries. The 20 emerging market countries are listed with asterisks in Table 3. Figure 12 compares the response of output to a positive private and public debt shocks for emerging market countries and for other developing countries.Footnote 8 In both groups of countries, output declines in response to a private debt shock and rises in response to a public debt shock.

Fig. 12

Impulse responses: emerging markets versus other developing countries. Notes: The figure presents impulse responses from a three-variable VAR in log real GDP, the ratio of public debt to GDP, and the ratio of private debt to GDP. The solid lines are the responses to a one-percent shock in each variable, and the dashed lines are 95% confidence intervals computed with the bias-corrected bootstrap

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Kim, Y.J., Zhang, J. The Relationship Between Debt and Output. IMF Econ Rev (2021).

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  • Public debt
  • Household debt
  • Firm debt
  • Foreign debt

JEL Classification

  • F34
  • F41
  • G32
  • G51
  • H63