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Avoiding debt traps: Fiscal consolidation, financial backstops and structural reforms

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  • Pier Carlo Padoan
  • Urban Sila
  • Paul van den Noord

Abstract

In this article we develop a simple and stylised analytical framework, which is both tractable and feasible to estimate, capturing several key dimensions of the sovereign debt crisis in Europe. We use it to examine if and how a combination of fiscal consolidation, structural reform and financial backstops can help countries, notably the southern euro-area countries, to escape from the debt trap. Our analysis confirms that the loss of fiscal policy space in countries trapped in bad dynamics inevitably requires that fiscal action be directed towards consolidation despite some output loss in the short run. In particular, reducing debt levels breeds stronger growth and results in lower sovereign risk premia. We identify also a very important role for structural reform to help countries escape from bad dynamics. Last but not least, we find that financial backstops are helpful, but only to “buy time”. This additional time must be used productively, for fiscal consolidation and structural reforms to bear fruit as well as to make progress with institutional reforms of the European monetary union.

Suggested Citation

  • Pier Carlo Padoan & Urban Sila & Paul van den Noord, 2012. "Avoiding debt traps: Fiscal consolidation, financial backstops and structural reforms," OECD Journal: Economic Studies, OECD Publishing, vol. 2012(1), pages 151-177.
  • Handle: RePEc:oec:ecokac:5k8xbnjbn9hl
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    File URL: http://dx.doi.org/10.1787/eco_studies-2012-5k8xbnjbn9hl
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    Cited by:

    1. Adler, Gustavo & Lizarazo, Sandra, 2015. "Intertwined sovereign and bank solvencies in a simple model of self-fulfilling crisis," International Review of Economics & Finance, Elsevier, vol. 39(C), pages 428-448.
    2. Agnello, Luca & Sousa, Ricardo M., 2015. "Can re-regulation of the financial sector strike back public debt?," Economic Modelling, Elsevier, vol. 51(C), pages 159-171.
    3. Balázs Égert, 2015. "The 90% public debt threshold: the rise and fall of a stylized fact," Applied Economics, Taylor & Francis Journals, vol. 47(34-35), pages 3756-3770, July.
    4. Balázs Égert, 2015. "Public debt, economic growth and nonlinear effects: Myth or reality?," Journal of Macroeconomics, Elsevier, vol. 43(C), pages 226-238.
    5. Kudrin, A. & Gurvich, E., 2015. "Government Stimulus or Economic Incentives?," Journal of the New Economic Association, New Economic Association, vol. 26(2), pages 179-186.
    6. Boris Cournède & Antoine Goujard & Álvaro Pina, 2013. "How to Achieve Growth- and Equity-friendly Fiscal Consolidation?: A Proposed Methodology for Instrument Choice with an Illustrative Application to OECD Countries," OECD Economics Department Working Papers 1088, OECD Publishing.
    7. Castro, Gabriela & Félix, Ricardo M. & Júlio, Paulo & Maria, José R., 2015. "Unpleasant debt dynamics: Can fiscal consolidations raise debt ratios?," Journal of Macroeconomics, Elsevier, vol. 44(C), pages 276-294.
    8. Beetsma, Roel & Mavromatis, Kostas, 2014. "An analysis of eurobonds," Journal of International Money and Finance, Elsevier, vol. 45(C), pages 91-111.
    9. Thorsteinn Thorgeirsson & Paul van den Noord, 2013. "The Icelandic banking collapse - was the optimal policy path chosen?," Economics wp62, Department of Economics, Central bank of Iceland.
    10. Ran Bi & Haonan Qu & James Roaf, 2013. "Assessing the Impact and Phasing of Multi-year Fiscal Adjustment; A General Framework," IMF Working Papers 13/182, International Monetary Fund.
    11. repec:sgh:gosnar:y:2017:i:6:p:79-93 is not listed on IDEAS
    12. John Farrugia & Owen, Grech, 2013. "Assessing the sustainability of Maltese government debt," CBM Working Papers WP/04/2013, Central Bank of Malta.

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