Geopolitical Shocks, Fiscal Dominance, and the TPI Conditionality: A Structural Conflict in the Euro Area

Thomas Le Roux

MPRA Paper from University Library of Munich, Germany

Abstract: Abstract This paper argues that the dominant risk to Euro Area stability has structurally shifted from cyclical inflation to a direct conflict between geopolitically-driven fiscal policy and central bank independence. We construct a novel quarterly dataset of exogenous geopolitical fiscal shocks (GEO_SHOCK) using a narrative approach (Ramey, 2011). A Structural Vector Autoregression (SVAR) for the EA aggregate finds these shocks are persistently inflationary, with a peak impact of +0.08% on the HICP. A Panel SVAR, robust to local projections, finds the shocks drive significant fragmentation: a 1-std-dev shock widens spreads in high-debt (90th percentile) member states by 22 basis points, an effect absent in pandemic-related fiscal shocks. The shock accounts for 34% of medium-term spread variance. A high-frequency event study confirms this, showing an immediate +11.2 bps impact on Italian spreads post-announcement. A counterfactual simulation shows that a TPI "spread cap" would stabilize debt but amplify inflation, quantifying the fiscal dominance trade-off.

Keywords: Fiscal Dominance; Monetary Policy; Geopolitical Risk; TPI; Fragmentation; SVAR; Local Projections (search for similar items in EconPapers)
JEL-codes: E52 E58 E62 E63 F45 H63 (search for similar items in EconPapers)
Date: 2025-11-07, Revised 2025-11-07
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