Public debt and economic growth: Is there a causal effect?

•We use an IV approach to study if public debt has a causal effect on GDP growth in OECD countries.•We propose a new instrument for public debt based on changes in debt due to valuation effects.•We confirm the presence of a negative correlation between debt and growth.•However, the link between debt and growth disappears once we correct for endogeneity.

This paper uses an instrumental variable approach to study whether public debt has a causal effect on economic growth in a sample of OECD countries. The results are consistent with the existing literature that has found a negative correlation between debt and growth. However, the link between debt and growth disappears once we correct for endogeneity. We conduct a battery of robustness tests and show that our results are not affected by weak instrument problems and are robust to relaxing our exclusion restriction. Our finding that there is no evidence that public debt has a causal effect on economic growth is important in the light of the fact that the negative correlation between debt and growth is sometimes used to justify policies that assume that debt has a negative causal effect on economic growth.