Public finances solvency in the Euro Area

Abstract

We assess public finances solvency for Euro Area countries, using quarterly data from 1999Q1 to 2020Q4. For most countries: (i) the primary budget balance reacts positively to the lagged debt-to-GDP ratio and past primary budget balances contribute to the reduction of the debt-to-GDP ratio, indicating a Ricardian fiscal regime. In the country-by-country analysis, we confirm (ii) the ”elusive character of fiscal sustainability” (Afonso and Jalles, 2016). Furthermore, in a panel framework: (iii) the response of revenues to government expenditures is higher from 2010 onwards, whereas the response is lower for higher average debt-to-GDP ratios; (iv) the response of the primary budget balance to the lagged debt-to-GDP ratio is lower from 2010 onwards and is higher for higher average debt-to-GDP ratios; (v) past primary budget balances enable the reduction of the debt-to-GDP ratio, especially before 2010 and also in countries whose average debt-to-GDP ratio is between 60% and 90% of GDP. Using a rolling window method, we find that (vi) the higher the lagged debt-to-GDP ratios, fiscal rule indexes, and sovereign ratings, the greater are the fiscal sustainability coefficients. Conversely, (vii) those coefficients are lower both after 2010 and during periods of legislative elections. These results have important implications for public finances management and solvency.