Debt overhang in the Eurozone: A spatial panel analysis

Abstract

The debt overhang hypothesis suggests that high debt levels retard prospects for GDP growth. We investigate the impact that debt overhang has had on recent GDP growth in the Eurozone, paying particular attention to the spillover effects that debt has on neighboring countries. We argue that in the Eurozone spatial effects are of crucial importance in modeling regional GDP growth, and find that a Spatial Durbin model is appropriate. We find strong evidence for the debt overhang hypothesis, confirming a concave relationship that has been found in other studies where low levels of debt can have a positive impact on GDP, but at some level a "turning point" occurs. The present study finds that this turning point occurs at a lower Debt/GDP ratio than found in prior studies, and separates out the direct and indirect (spillover) effects on neighboring countries' GDPs.