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Sustainability of Government Debt in the EU

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  • Lejour, Arjan
  • Lukkezen, Jasper
  • Veenendaal, Paul

Abstract

This paper addresses the sustainability of government debt in Europe and is motivated by the recent debt increases following the crisis. We evaluate the sustainability in a time frame of ten years in which governments will be able to implement budget rules to get budget deficits under control. We develop a fiscal sustainability model for selected EMU member states that uses stochastic inputs based on historic data, closely following van Wijnbergen’s (van Wijnbergen and Budina, 2008) approach. We simulate the development of government debt as a percentage of GDP and show its expectation value including a confidence interval for a member state conditional on deficit reduction scenarios and the behaviour of other EMU member states. Using OECD projections as a baseline, we find that without additional fiscal consolidation and taking into account the public costs of ageing until the end of the projection period, budget deficits in all selected EMU countries will rise and sovereign debt is not sustainable, apart from Belgium. Even ignoring the cost of ageing, consolidation of sovereign debt is necessary for nearly all EMU countries. The consolidation proposed by the OECD would eliminate the doubts on sustainability of Belgium, Dutch, German, Italian, Portuguese and French bonds. For Ireland, Greece and Spain additional actions are required on top of the consolidation in the OECD projections. Together with a review of spillovers and stress-tests performed with our model we conclude that coordination of fiscal policies in the EMU is necessary.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 30139.

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Date of creation: 07 Jun 2010
Date of revision: 07 Jun 2010
Handle: RePEc:pra:mprapa:30139

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Keywords: EU; government debt; cross border spillovers; euro;

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References

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  1. Buiter, Willem H., 2009. "The Limits to Fiscal Stimulus," CEPR Discussion Papers 7607, C.E.P.R. Discussion Papers.
  2. Stanley Fischer & Ratna Sahay & Carlos A. Végh Gramont, 2002. "Modern Hyper- and High Inflations," IMF Working Papers 02/197, International Monetary Fund.
  3. Roel Beetsma & Massimo Giuliodori, 2010. "The Macroeconomic Costs and Benefits of the EMU and Other Monetary Unions: An Overview of Recent Research," Journal of Economic Literature, American Economic Association, vol. 48(3), pages 603-41, September.
  4. Matthew B. Canzoneri & Robert E. Cumby & Behzad T. Diba, 1998. "Is the Price Level Determined by the Needs of Fiscal Solvency?," NBER Working Papers 6471, National Bureau of Economic Research, Inc.
  5. Massimo Giuliodori & Roel Beetsma, 2005. "What are the Trade Spill-Overs from Fiscal Shocks in Europe? An Empirical Analysis**," De Economist, Springer, vol. 153(2), pages 167-197, 06.
  6. Riccardo Faini, 2006. "Fiscal policy and interest rates in Europe," Economic Policy, CEPR & CES & MSH, vol. 21(47), pages 443-489, 07.
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Cited by:
  1. Jasper Lukkezen & Hugo Rojas-Romagosa, 2013. "Stochastic debt sustainability indicators," Revue de l'OFCE, Presses de Sciences-Po, vol. 0(1), pages 97-121.

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