Effect of Government Debt, Interest Rate, and Bank Risk-Taking on Economic Growth

Abstract

This paper examines the effect of government debt, interest rates and bank risk-taking on economic growth in a panel of countries. With an initial sample dataset for 2000–2024 that included 195 countries, data limitations caused by missing values narrowed the focus on to only 34 countries with all required factors from 2000–2021. Economic growth (dependable variable) is the five-year average of real GDP annual growth rates (%), and the independent variables consist of government net debt as a percentage of GDP, lending interest rate and bank Z-scores proxy for banking risk-taking. The analyses make use of panel data econometric methods, such as pooled OLS, fixed and random effect models being used to control for cross-country and across time heterogeneity. Choice of fixed vs random effects model is based on the Hausman test, and results are robust to heteroskedasticity-robust standard errors clustered at the country level. Moreover, Robustness checks like F-test for fixed effects, Breusch-Pagan Lagrange Multiplier test for random effects, Wooldridge test for serial correlation and Breush-Pagan test for heteroskedasticity are conducted to ensure the consistency of estimates. The empirical findings reveal that government debt and interest rate have significant effects on economic growth, whereas the impact of bank risk-taking is conditional upon financial stability and institutional environments. These results underscores some policy implications for the narrow purpose of debt management, monetary and banking regulation to sustain the economic growth. This study sheds light on the role of macroeconomic and financial forces in growth formation, namely fiscal policy, monetary conditions and bank sector soundness. The limitations include a relatively small sample size owing to missing data, which highlights avenues for future research to extend the database and to examine more macro-financial variables.