The Effects of Macroeconomic and Budget Balance Shocks on Public Debt Trajectories in the Euro Area

Olegs Tkacevs and Karsten Staehr ()
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Olegs Tkacevs: Latvijas Banka

No 2025/08, Working Papers from Latvijas Banka

Abstract: This paper examines the effects of macroeconomic and budget balance shocks on public debt trajectories in the euro area. Country-specific SVAR models are used to identify various shocks, which are subsequently incorporated into local projection models that use panel data to estimate the impulse responses. The analysis indicates that a positive GDP shock leads to a persistent decline in the debt-to-GDP ratio, while a positive GDP deflator shock reduces the debt ratio only temporarily. A positive interest rate shock results in a substantial and lasting increase in the debt ratio. A positive primary balance shock, reflecting discretionary austerity, lowers the debt ratio considerably, albeit with a lag of around one year. We find evidence of statedependent and non-linear effects. Fiscal austerity is more effective in reducing debt after periods of economic expansion than after recessions, and more effective when the initial public debt is low than when it is high. Moreover, a positive GDP shock reduces the debt stock to a larger extent when the debt stock is large than when it is low. Finally, the response of debt to a positive budget balance shock is more persistent and statistically significant when the shock is large.

Keywords: public debt; fiscal policy; macroeconomic shocks; euro area (search for similar items in EconPapers)
JEL-codes: E62 H6 H63 (search for similar items in EconPapers)
Date: 2025-10-14
New Economics Papers: this item is included in nep-eec, nep-ifn and nep-pbe
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