Debt and Private Investment: Does the EU Suffer from a Debt Overhang?

Willem Vanlaer (), Mattia Osvaldo Picarelli and Wim Marneffe
Additional contact information
Willem Vanlaer: Hasselt University, Faculty of Applied Economics
Wim Marneffe: Hasselt University, Faculty of Applied Economics

Open Economies Review, 2021, vol. 32, issue 4, No 7, 789-820

Abstract: Abstract This paper exploits a panel of 28 European Union (EU) countries between 1995 and 2016 to analyze whether higher debt resulted in lower private investment – the so called debt overhang effect. We deal with the potential endogeneity between private investment and other macroeconomic determinants by applying an instrumental variable approach (GMM). Our results support the debt overhang hypothesis and indicate that this relationship only works through the public debt channel. In our baseline regression, a 10 percentage point increase in public debt reduced private investment by €18.32 billion, given the levels of private investment prevalent in 2016. By contrast, private debt does not appear to be a significant determinant of private investment. These results hold after controlling for a number of factors that might have caused public debt to increase and private investment to decrease. While our analysis focuses on the financial sector channel, we find no evidence that public debt tightens the credit constraints for private firms or worsens the public debt overhang. We also show that government bailouts of the financial sector, which could alleviate financial distress and boost credit provision, do not appear to be effective in mitigating the public debt overhang effect. Finally, we find evidence that the financial openness of a country does alleviate the negative impact of public debt on private investment. This might suggest that attracting foreign capital compensates for a contraction in the domestic pool of financial resources due to higher public debt levels.

Keywords: Debt overhang; Private investment; Dynamic panel data (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
http://link.springer.com/10.1007/s11079-021-09621-x Abstract (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:kap:openec:v:32:y:2021:i:4:d:10.1007_s11079-021-09621-x

Ordering information: This journal article can be ordered from
http://www.springer. ... cs/journal/11079/PS2

DOI: 10.1007/s11079-021-09621-x

Access Statistics for this article

Open Economies Review is currently edited by G.S. Tavlas

More articles in Open Economies Review from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().