Role of uncertainty in debt-growth nexus
Role of uncertainty in debt-growth nexus

Summary/Abstract: This paper analyses uncertainty as one of the factors that affect the public debt-growthnexus. We put forward a hypothesis that uncertainty mediates the effect of publicdebt on economic growth. The empirical examination of the mediating effect is basedon the neoclassical growth equation and consistent with specifications previously usedto analyse the sources of heterogeneity in the debt-growth relationship. Since onepart of the uncertainty is financial risk, which is closely related to the financial sectorstability, we use interest rate spread as a main variable, and the risk premium on lendingas an alternative one to proxy financial risk and thus, to some extent, uncertainty. Ourresults show that lower uncertainty is related to a bigger positive effect of debt on growthand a higher turning point in the debt-growth nexus. On the contrary, higher uncertaintyleads to a lower positive and more considerable negative effect of debt on growth in bothlinear and quadratic specifications.

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