A Stochastic Approach to Debt Sustainability in EU Countries

The aim of this paper is to examine the path of public debt for a selection of European countries. To this end, we adopt a stochastic approach that explicitly accounts for uncertainty in the macroeconomic variables underlying the debt-to-GDP ratio. The analysis builds on the standard debt accumulation identity, which links the dynamics of public debt to the primary budget balance, the real interest rate, and the economic growth rate. By estimating autoregressive models for the above variables and considering the variance-covariance matrix of the residuals to capture instantaneous causality, we obtain a distribution of debt-to-GDP ratio values for each year. From this distribution of values, it is possible to determine the probability of meeting a specific target. The results suggest that the debt-to-GDP ratio declines for Belgium, Greece, Portugal, and Spain, while it follows a moderately explosive trajectory for France and Italy. By 2030, the probability of the debt-to-GDP ratio falling below 100% is approximately 80% for Portugal, with similar probabilities for Spain and Belgium. In contrast, this probability is considerably lower for Greece, Italy, and France. In fact, Greece and Italy are the countries whose fiscal fragility is highest — followed by France, Belgium and Spain—, while Portugal has the strongest fiscal position