Leveraging interest-growth differentials: Hidden effects of government financial assets in the European Union

Conditions of fiscal sustainability have been widely studied in the literature. Fiscal reaction functions or cointegration between government revenues and expenditures are two approaches that economists have been paying their attention, not only on a theoretical perspective, but also empirically assessing the sustainability of several economies during different timespans. Whereas a predominant focus has been attributed to primary deficits, little attention has been dedicated to government financial assets contribution to government debt paths. Given that government financial assets represent a large proportion of gross debt accumulation, we enquire about their role on government debt leveraging of economic growth over interest rates, focusing on a channel of gross debt, investment, external balance and ratings, in 27 European Union economies during the period from 2000 to 2022. Large heterogeneities in the statistical characteristics of the series and impacts of financial assets on interest rate-growth rate differentials call for a closer attention to financial assets on a granular approach at individual country level, rather than on the aggregate. Our results highlight the importance of government financial assets holdings to the short and long-run debt trajectories, enhancing or potentially undermining gains from primary deficits consolidation efforts and consequently on the differentials between interest rates and output growth.