The relationship between public debt and economic growth has long been a subject surrounded by much controversy. Even after many decades of debate there is still no theoretical consensus regarding this relationship. According to some theories the relationship is positive while other theories say it is negative. Still others argue that there is no systematic association. In this thesis four regression equations have been created in order to analyze the impact of internal debt and external debt on economic growth in Denmark. The results show that the relationship between growth in GDP and internal debt as well as external debt is positive. They also show that the impact of external debt on growth in GDP is greater than the impact of internal debt on growth in GDP.
In this thesis the most seminal and cited theories from the past centuries will be evaluated by comparing them with the empirical evidence. It will be shown that the Keynesian approach is the most prudent given the results of the empirical analysis as well as the trend and structure of public debt in Denmark.
The high Danish taxes and duties combined with the fixed exchange rate policy prompt that the public deficit is covered by creation of public debt. The primary purpose of the deficit spending is in order to finance the extensive Danish welfare state which provides many benefits such as a well-educated and healthy workforce in addition to social stability.
From 2013 and onwards Denmark will be one of the only countries that fulfills all the requirements in the Stability and Growth Pact of the Economic and Monetary Union of the European Union. From 2001 to 2011 the total government debt has fallen from 38.5 percent of GDP to 23.1 percent of GDP. This is mainly due to a large increase of the governmental assets in the Danish Central Bank. This increase will enable the government to keep the refinancing rate at a minimum in the future.
Denmark is considered to be one of the safest countries in the world to invest in which has caused the interest rate on Danish government bonds to plummet. The low interest rates keep the Danish interest payments at a very low level despite an increase in public debt since 2008.
The private sector’s propensity to save is at the highest level since World War II and the net exports have risen to historical levels during the financial crisis. Combined with the contractionary fiscal policy of the newly elected government this has caused aggregate demand to fall sharply and thus has resulted in stagnation of the growth in GDP in addition to sharply rising unemployment rates.
The thesis shows that due to the low interest rates on government bonds, it is recommended that the Danish government uses this opportunity to finance an expansionary fiscal policy which will produce an increase in aggregate demand and as such improve the growth in GDP and reduce unemployment rates. The primary focus should be on creation of short term debt since this type of debt is primarily owned by foreign investors and it has been shown in this thesis that external debt has a greater positive impact on GDP than internal debt.