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Major public debt reductions: Lessons from the past, lessons for the future

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  • Nickel, Christiane
  • Rother, Philipp
  • Zimmermann, Lilli

Abstract

The financial crisis of 2008/2009 has left European economies with a sizeable public debt stock bringing back the question what factors help to reduce these fiscal imbalances. Using data for the period 1985-2009 this paper identifies factors determining major public debt reductions. On average, the total debt reduction per country amounted to almost 37 percentage points of GDP. We estimate several specifications of a logistic probability model. Our findings suggest that, first, major debt reductions are mainly driven by decisive and lasting (rather than timid and short-lived) fiscal consolidation efforts focused on reducing government expenditure, in particular, cuts in social benefits and public wages. Second, robust real GDP growth also increases the likelihood of a major debt reduction because it helps countries to "grow their way out" of indebtedness. Third, high debt servicing costs play a disciplinary role strengthened by market forces and require governments to set up credible plans to stop and reverse the increasing debt ratios. JEL Classification: C35, E62, H6

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 1241.

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Date of creation: Sep 2010
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Handle: RePEc:ecb:ecbwps:20101241

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Keywords: binary choice models; Fiscal Policy; public debt;

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  1. Alfred Greiner & Uwe K├Âller & 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.
  2. Bas van Aarle & Harry (ed.) Garretsen, 2001. "Keynesian, Non-Keynesian or No Effects of Fiscal Policy Changes? The EMU Case," CESifo Working Paper Series 570, CESifo Group Munich.
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