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Geopolitical Shocks, Fiscal Dominance, and the TPI Conditionality: A Structural Conflict in the Euro Area

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  • Le Roux, Thomas

Abstract

This paper argues that the dominant risk to Euro Area stability has structurally shifted from cyclical inflation to a direct conflict between geopolitically-driven fiscal policy and central bank independence. We construct a novel quarterly dataset of exogenous geopolitical fiscal shocks (GEO_SHOCK) using a narrative approach (Ramey, 2011). A Structural Vector Autoregression (SVAR) for the EA aggregate finds these shocks are persistently inflationary, with a peak impact of +0.08% on the HICP. A Panel SVAR, robust to local projections, finds the shocks drive significant fragmentation: a 1-std-dev shock widens spreads in high-debt (90th percentile) member states by 22 basis points, an effect absent in pandemic-related fiscal shocks. The shock accounts for 34% of medium-term spread variance. A high-frequency event study confirms this, showing an immediate +11.2 bps impact on Italian spreads post-announcement. A counterfactual simulation shows that a TPI "spread cap" would stabilize debt but amplify inflation, quantifying the fiscal dominance trade-off.

Suggested Citation

  • Le Roux, Thomas, 2025. "Geopolitical Shocks, Fiscal Dominance, and the TPI Conditionality: A Structural Conflict in the Euro Area," MPRA Paper 126750, University Library of Munich, Germany, revised 07 Nov 2025.
    • Handle: RePEc:pra:mprapa:126750
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    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • F45 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Macroeconomic Issues of Monetary Unions
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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