From “Debt and Growth: Is There a Magic Threshold?” by Andrea Pescatori, Damiano Sandri, and John Simon and distributed by the IMF:
Is there a particular threshold in the level government debt above which the medium-term growth prospects are dramatically compromised? The answer to this question is of critical importance given the historically high level of public debt in most advanced economies. Yet there is currently no agreement on the answer and it is the subject of heated academic and political debate. One camp has argued that high levels of debt are associated with particularly large negative effects on growth. For example, an influential series of papers by Reinhart and Rogoff (2010, 2012) argues that there is a threshold effect whereby debt above 90 percent of GDP is associated with dramatically worse growth outcomes.
An opposing perspective is advanced by those who dispute the notion that there is a clear debt threshold above which debt sharply reduces growth and raise endogeneity concerns whereby weak growth is the cause of particularly high levels of debt. Thus, according to this view, the priority should be increasing growth rather than reducing debt and, consequently, that much less short-term fiscal austerity is appropriate.
This paper makes a contribution to the debate by presenting new empirical evidence based on a different way of analyzing the data and a sizeable dataset. Our methodology is based on the analysis of the relation between debt and growth over longer periods of time that has the potential to attenuate the concerns of reverse causality from growth to debt.
Our results do not identify any clear debt threshold above which medium-term growth prospects are dramatically compromised. On the contrary, the association between debt and medium-term growth becomes rather weak at high levels of debt, especially when controlling for the average growth performance of country peers. We also find evidence that the debt trajectory can be just as important, and possibly more important, than the level of debt in understanding future growth prospects. Indeed, countries with high but declining levels of debt have historically grown just as fast as their peers. We also find, however, that high levels of debt are weakly associated with higher output volatility. This suggests that high levels of debt may still be associated with market pressure or fiscal and monetary policy actions that, even if they do not have particularly large negative effects on medium-term growth, destabilize it.
This is an interesting, ongoing theoretical argument that should really have no impact on whether we should reform entitlements ASAP. We should, of course, so that (a) tax dollars are used more efficiently, (b) the programs provides better services to those who need them the most, and (c) “market pressure” situation where changes will need to be blunt are avoided.