Conditional forecast for public debt and threshold effects: Evidence from South EU countries

In this study, we employ a Bayesian Seemingly Unrelated regression (SUR) model for the South EU countries to make a conditional forecast for the public debt in a medium term-horizon (six years ahead). Our forecast incorporates multiple macroeconomic shocks, specifically: (i) fiscal austerity, captured through changes in government budget balances; (ii) the international business cycle, proxied by US GDP growth; and (iii) energy cost shocks, proxied by fluctuations in global oil prices. Adopting various scenarios, the results show that lower budget deficit and higher economic growth lead to the fastest downward debt trajectory. The findings also suggest that the optimum level of budget deficit limit is 2.7 % of GDP and is achieved when government expenditures and revenue are lower than 40.9 % and 38.19 % respectively. Interestingly, the international business cycle plays a fundamental role, since economic growth of the South EU countries exerts even more pressure to debt reduction when US GDP growth is higher than 3 %. The effect of inflation on debt conditioned by energy cost, the results indicate that inflation may cause more debt when oil price is high, but this effect seems to be for a short-term period. The main policy implication from the results is that the downward trajectory of debt hinges on sustainable fiscal limits and economic expansion.