The Nonlinear Effect of Public Debt on Economic Growth in Jordan over the Period 1980 - 2018

At reasonable levels, public debt enhances growth and promotes welfare. However, at high levels it turns out to be detrimental. When does the effect of public debt change from good to bad? To address this question locally, this study investigates empirically the long-run relationship between public debt and economic growth in Jordan, using time series data over the period 1980 - 2018. The modeling of the debt–growth relationship is based on theoretical arguments and empirical considerations and analyzed by adopting both linear and non-linear specifications. The model is estimated by fully modified ordinary least squares (FM-OLS) approach, the empirical results confirm that public debt is negatively associated with economic growth in the long-run. On the other hand, investment, labor force growth, and openness of trade are found to be positively associated with economic growth in the long-run. There is an evidence of non-linearity between public debt and economic growth in the long-run, with only high levels of debt exceeding 78 percent of GDP, having a significant negative effect on growth. This result demonstrates an inverted U-shaped curve in the debt-growth relationship in Jordan, in other words, the direction of the effect of public debt on economic growth transforms smoothly from positive to negative depending on the level of indebtedness. Accordingly this study emphasizes the need to take actions not only to alleviate public debt but also to place it on a descending pathway in the long-term. As analyzing the relationship between public debt to GDP ratio and economic growth has demonstrated to be necessary for governments to shape suitable fiscal policy guiding principles. It is recommended that the government is permitted to accumulate debt to no more than 78% of GDP; otherwise it will exert a negative effect on the economy.