Impact of public debt sustainability on fiscal policy in Croatia

Abstract

This paper analyses the impact of public debt level and its (un)sustainability on fiscal policy in Croatia in the 2001–2015 period. A switching regression approach is used to distinguish different regimes when government spending, i.e. fiscal policy has more or less impact on economic growth during different cycles. In the second part, the structural VAR model is used to analyse the dynamic effects of government spending on domestic demand in Croatia. To observe the public debt effects on a fiscal policy, a “closed” model is compared with an “extended” model which includes a debt-to-GDP indicator. Results show a negative impact of recession on public debt sustainability and confirm the main thesis that public debt level significantly affects and reduces the effectiveness of fiscal policy in Croatia.