Optimal Government Debt Ratio that Maximizes Economic Growth

This paper extends the work of Smyth and Hsing (1995) to empirically estimate the optimal government debt ratio that maximizes economic growth using panel data of OECD countries. Empirical analysis is conducted based on an economic growth model, where the growth rate of GDP is specified as a function of the government debt ratio, the government debt ratio squared, and the growth rate of labor and capital. The panel regression results of the GDP growth model augmented by the government debt ratio indicate a significant inverse U-shaped relationship between the GDP growth rate and the government debt ratio. The optimal government debt ratio corresponding to the maximum GDP growth rate is calculated using the estimated coefficients of the panel regression, and the result stands at around 70%. Empirical results of this paper suggest that government debt of major advanced countries should be managed around such optimal level to maximize and sustain economic growth.