the sample of overhang countries as implied by (kernel) growth regressions without country fixed effects, and investigate which controls affect the significance of the effect of debt in a sample where it is initially significantly negative. We focus in particular on institutional characteristics of the economy.

The paper’s second step involves departing from reduced form growth regressions, and performing direct tests of the mechanisms that underpin the debt Laffer curve. Overhang countries are regrouped in a balanced panel which we subject to an event study, where the onset of debt overhang is the shock whose chronology we seek to characterize. We use our non-parametric estimates to date the threshold level of indebtedness, and ask three questions of the event study. First, is investment falling precipitously about the overhang date? Theories of optimal default suggest investment should respond at or after the overhang date, but not before. A collapse in investment prior to the overhang date would be suggestive that an explosion of the debt to GDP ratio is a symptom, rather than the cause of an investment slump. Second, is economic policy observably deteriorating at or after the overhang date? Theories of optimal debt contracts suggest incentives alter as a result of reaching a threshold level of indebtedness; again, the reverse timing is suggestive of reverse causality. Third, do the terms under which borrowing is contracted worsen noticeably at the threshold debt level? There, debt overhang occurs because creditors become unable to write incentive compatible contracts with highly indebted debtors, and choose instead to exact punitive premia. This effect should be tempered somewhat in environments where creditors are protected, or have access to monitoring technologies that limit debtors’ moral hazard, as for instance in economies with developed financial markets.

Our results are as follows. Most of our estimates are supportive of a debt Laffer curve - or at least a negatively sloped relation between debt and growth at high levels of indebtedness. On average, debt overhang occurs when the face value of debt reaches 55 to 60 percent of GDP or 200 percent of exports, or when the present value of debt reaches 35 to 40 percent of GDP or 140 percent of exports. Then, initial debt tends to be associated with subsequently low growth. These thresholds apply within-countries, accounting for countryspecific institutional arrangements. They are valid for the average developing economy in our sample. Still, institutions do matter for debt and growth. In particular, we find that government effectiveness, the rule of law and bureaucratic quality all correlate positively with economic growth, and tend to limit debt build-up. Debt overhang may still happen in economies endowed with good institutions, but for higher values of debt.<sup>3</sup> The event study provides clear support for a fall in investment after the onset of overhang. We uncover some evidence that economic policy -in particular price stability- deteriorates. Indices capturing the overall quality of economic policy markedly worsen once the overhang threshold is reached. Interest rates on new borrowing, on the other hand, tend to fall. This runs contrary to the theory, but can actually stem from extensive rationing. Indeed, we find that at the overhang date, quantities lent by the private sector collapse precipitously, and the bulk of lending originates then from multilateral official agencies, at concessional rates.

We ascertain our results indeed arise because of overhang mechanisms, and rule out the following two prominent alternatives. First, we consider the possibility that world interest

> 3 Our event study ignores this heterogeneity, in that it uses the average estimated overhang threshold for all countries.

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