Abstract

This study investigates the nonlinear relationship between public debt and economic growth within the European Union (EU), emphasizing threshold effects beyond which debt accumulation adversely impacts growth. Using an unbalanced panel of 27 EU member states from 1995 to 2023, we apply a dynamic panel estimation technique based on the two-step System Generalized Method of Moments (GMM) to address endogeneity, reverse causality, and the persistence of debt and growth dynamics. Additionally, a panel threshold regression model is employed to estimate the critical debt-to-GDP ratio where the marginal effect of debt becomes significantly negative. The findings confirm a nonlinear debt-growth relationship. Moderate debt levels are generally neutral or mildly supportive of growth, particularly in countries with strong institutions and sound fiscal frameworks. However, once public debt exceeds the estimated threshold of 84–90% of GDP, its marginal impact turns significantly negative, especially in countries with weaker governance and elevated sovereign risk. The results remain robust across various specifications, subsample analyses, and when excluding financial crisis years. These results have direct implications for EU fiscal policy. They support revising fiscal rules to reflect country-specific institutional and macroeconomic conditions, allowing more flexibility in low-debt contexts and stricter constraints in high-debt, institutionally weak environments.

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