The effects of fiscal shocks on financial stability in the euro area

Cyriac Guillaumin and Manlan N'Goran
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Manlan N'Goran: CREG - Centre de recherche en économie de Grenoble - UGA - Université Grenoble Alpes

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Abstract: The objective of this paper is to enhance comprehension of the impact of fiscal shocks on the financial stability and financial cycles of the euro area, focusing especially on public debt levels. To do this, we use i) the methodology developed by Hansen (2000) and ii) the non-linear panel local projection impulse response function approach developed by Jordà (2005). Our results are numerous. First, we identify a threshold of 71% for the public debt to GDP ratio, surpassing the Maastricht criterion of 60%. Second, in instances where public debt is high, shocks in government spending have a negative influence on the financial cycle; yet they bolster financial stability, indicating intricate interactions. Conversely, in situations where public debt is low, these shocks initially stimulate both the financial cycle and stability, but their effects diminish over time. Third, revenue shocks in high debt regimes moderately stimulate the financial cycle, but they have a detrimental impact on financial stability. These findings highlight the importance of coordinating fiscal and macroprudential policies and contemplating the implementation of a fiscal union within the euro area to ensure enduring financial stability and resilience.

Date: 2025-09-10
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Published in 27th INFER Annual Conference, Department of Economics and Law; University of Rome Sapienza; International Network for Economic Research, Sep 2025, Rome, Italy

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-05330258

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