Fiscal fatigue and debt sustainability: Empirical evidence from the Eurozone 1980–2013

Abstract

The sharp rise in debt and the long fiscal consolidation process in some Eurozone countries has not always led to a reduction in debt-to-GDP ratios. As a result, some authors suggest that the primary balance may stop adjusting once debt has reached a certain limit. We show that the reaction of the primary balance to rising debt depends on the underlying growth and institutional dynamics. In particular, economic growth can have an exponential effect on the primary balance. Also, we show that rising debt, when accompanied by growth and a favorable political context may lead to an improvement in the primary balance.