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Debt Sustainability and Financial Crises: Evidence from the GIIPS

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  • Gabriella Deborah Legrenzi
  • Costas Milas

Abstract

We assess the sustainability of the public finances of Greece, Ireland, Italy, Portugal and Spain (GIIPS), allowing for possible non-linearities in the form of threshold behaviour of the fiscal authorities. We provide some evidence of fiscal sustainability when debt gets “too high” relative to a threshold which is not necessarily fixed but varies with the level of debt relative to its recent history and/or the occurrence of a financial crisis. However, the Greek and Italian debt-to-GDP threshold levels (over which adjustment takes place) exceed 87% and rise further in periods of financial crises. This arguably adds to international investors’ concerns, and as a result, raises the yields demanded for holding Greek and Italian debt. As debt is rolled over at high interest rates, fiscal prospects worsen making default more likely and adding to contagion effects from one Eurozone country to another.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3594.

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Date of creation: 2011
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Handle: RePEc:ces:ceswps:_3594

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Keywords: debt sustainability; financial crisis;

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References

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  1. António Afonso, 2005. "Fiscal Sustainability: The Unpleasant European Case," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, Mohr Siebeck, Tübingen, vol. 61(1), pages 19-, March.
  2. Alfred Greiner & Uwe Köller & Willi Semmler, 2007. "Debt sustainability in the European Monetary Union: Theory and empirical evidence for selected countries," Oxford Economic Papers, Oxford University Press, vol. 59(2), pages 194-218, April.
  3. Bertola, Giuseppe & Drazen, Allan, 1993. "Trigger Points and Budget Cuts: Explaining the Effects of Fiscal Austerity," American Economic Review, American Economic Association, American Economic Association, vol. 83(1), pages 11-26, March.
  4. Reinhart, Carmen M. & Rogoff, Kenneth S., 2010. "Growth in a Time of Debt," Scholarly Articles 11129154, Harvard University Department of Economics.
  5. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, Princeton University Press, edition 1, volume 1, number 8973.
  6. Michael G. Arghyrou & Kul B Luintel, 2002. "Government Solvency: Revisiting some EMU Countries," Economics and Finance Discussion Papers, Economics and Finance Section, School of Social Sciences, Brunel University 02-24, Economics and Finance Section, School of Social Sciences, Brunel University.
  7. Bohn, Henning, 2007. "Are stationarity and cointegration restrictions really necessary for the intertemporal budget constraint?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 54(7), pages 1837-1847, October.
  8. Quintos, Carmela E, 1995. "Sustainability of the Deficit Process with Structural Shifts," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 13(4), pages 409-17, October.
  9. Sarno, Lucio, 2001. "The behavior of US public debt: a nonlinear perspective," Economics Letters, Elsevier, Elsevier, vol. 74(1), pages 119-125, December.
  10. Georgios Chortareas & George Kapetanios & Merih Uctum, 2008. "Nonlinear Alternatives to Unit Root Tests and Public Finances Sustainability: Some Evidence from Latin American and Caribbean Countries," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, Department of Economics, University of Oxford, vol. 70(5), pages 645-663, October.
  11. Lin, Chien-Fu Jeff & Terasvirta, Timo, 1994. "Testing the constancy of regression parameters against continuous structural change," Journal of Econometrics, Elsevier, Elsevier, vol. 62(2), pages 211-228, June.
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Cited by:
  1. António Afonso & João Tovar Jalles, 2012. "Revisiting fiscal sustainability: panel cointegration and structural breaks in OECD countries," Working Papers Department of Economics, ISEG - School of Economics and Management, Department of Economics, University of Lisbon 2012/29, ISEG - School of Economics and Management, Department of Economics, University of Lisbon.
  2. Ruthira Naraidoo & Leroi Raputsoane, 2013. "Debt sustainability and financial crises in South Africa," Working Papers, University of Pretoria, Department of Economics 201352, University of Pretoria, Department of Economics.
  3. Aviral Kumar Tiwari, 2012. "Debt Sustainability in India: Empirical Evidence Estimating Time-Varying Parameters," Economics Bulletin, AccessEcon, vol. 32(2), pages 1133-1141.

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