EFSD Working paper WP/20/4 «Optimal Debt and the Quality of Institutions»

30 November 2020

Amid the COVID-19 pandemic policymakers now face the dilemma of whether to stimulate infrastructure development by raising debt, which may reduce future flexibility, or to strengthen their fiscal positions. In order to shed light on this issue, the present study analysed an optimal debt level, taking into account countries’ institutional characteristics.

The key findings on the debt–GDP relationship reveal monotonic increase of the debt threshold from less institutionally developed countries to more developed ones. While economies with weak political institutions feature a 37% debt-to-GDP threshold, in countries with strong institutions the debt threshold rises above 55% of GDP. This distribution of debt thresholds stresses the greater resilience of the advanced economies to growing debt burdens compared to their less institutionally sustainable peers.