Investigating threshold effects of public debt on economic growth for Zambia (1980 - 2015).

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Matongo, Chimuka Hakalima
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The University of Zambia
Debt overhang theory suggests that debt has a Laffer curve type of relationship with economic growth. This implies that there is a threshold value of debt, beyond which, debt accumulation will negatively affect economic growth. This paper sought to contribute to existing literature by investigating the existence of a Laffer curve relationship between debt and economic growth in Zambia. Unlike other studies, this study focuses on estimating the optimal growth maximizing public debt threshold for Zambia and not only investigating the existence of a relationship between these variables. . This study employs the approach used by Mupungu and Le Roux (2015) who considered the threshold effect of public debt on economic growth in Zimbabwe by estimating a bivariate quadratic model and a multivariate model to control for model specification. The study additionally employs the Threshold Autoregressive (TAR) model to validate results from the optimization approach. The paper finds evidence of the existence of a Laffer curve relationship by plotting the predicted values of GDP from the bivariate model against debt-to-GDP ratio. The tipping point is found to be at 36.6 percent of debt-to-GDP ratio after maximizing the resultant equation of the model. The multivariate threshold autoregressive model reveals that for the Zambian case, debt has an insignificant effect on growth below 28.4 Percent of GDP and a significant negative effect once it goes beyond 44.9 percent of GDP. This means that the 36.6 percent threshold value from maximizing the bivariate model is confirmed by the TAR model. Since the Threshold model found that there is no significant relationship between debt and GDP before the tipping point, Zambia should ensure that debt financing below the optimal threshold is used for growth enhancing activities and not financing government non-capital expenditures.
Thesis of Master of Arts Degree in Economics.