In this paper, we will present a simple growth model in which the impact of budget deficits on government spending on investments depends on the public debt to GDP ratio. Whenever the public debt ratio is low, the impact of the deficit is positive, since the debt burden can be absorbed by a reduction in public consumption. On the other hand, whenever the public debt ratio is very high, public consumption can no longer be reduced, such that it is government investment that decreases. Therefore, there is an inverse relation between budget deficits and public spending. Our empirical analysis conducted on an econometric model with threshold effects for a panel of 22 OECD countries confirms the non-linear effects of budget deficits on public investment.
- public investment
- non-linear effects of fiscal policy