Fiscal sustainability, fiscal reactions, pitfalls and determinants

Abstract

We examine the sustainability of public finances and its determinants for 19 Eurozone countries from 1995 to 2020. We conclude for the existence of panel cointegration between government revenues and expenditures; primary government balance and lagged public debt-to-GDP ratio; and public debt-to-GDP ratio and lagged primary government balance. The estimated fiscal reaction functions suggest the existence of a Ricardian fiscal regime, although there is also evidence of a non-Ricardian fiscal behaviour. Finally, modelling via time-varying coefficients, we find that fiscal sustainability increases with the output gap, fiscal rules indices and current account balances. Inflation and sovereign ratings assigned by the main rating agencies produce mixed results.