Title and Abstract
Determinants and output growth effects of debt distress
While the potential perils of debt distress are well understood, considerable uncertainty remains as to the empirical magnitude of the costs of debt distress, particularly with respect to output growth losses induced by debt distress. In this paper, we propose a data-driven yet structured empirical model to characterize the cross-country output growth implications of a country being in debt distress. Our dynamic panel model with debt regime switching and endogenous sample selection in particular allows us to both consider the direct effect of indebtedness on output growth as well as its indirect effect through changes in the distress probability. Our empirical evidence suggests that the debt distress vs. output growth nexus is nonlinear: The direct effect of increases in the debt burden on output growth is either relatively small or insignificant even in episodes of debt distress; an overall significant effect arises through the indirect effect of increases in the debt burden increasing the probability of debt distress. Also importantly, the probability of debt distress is in any case state dependent, varying strongly with a country's institutional and policy track record.
Goethe University Frankfurt
University of Exeter
The World Bank