Fiscal policy asymmetries and the sustainability of government debt in the Euro Area

Abstract

This paper empirically analyzes fiscal policy sustainability and the cyclicality in 19 Euro Area countries using data on government debt, primary deficit and the output gap. We investigate this over quarterly intervals, which begin in 1980:1 and end in 2019:3. We find that primary deficit/GDP ratio responds negatively to an increase in government debt in weak economic times, which we interpret as sustainable fiscal policy in the economic times of distress. The best fitting threshold model and the Markov switching model do not support fiscal policy sustainability during economic expansions. Hence, we interpret the robust sustainable results during times of distress as evidence that policy makers are concerned with the fiscal rules and targets in weak economic times. Regarding the cyclicality of fiscal policy, we find symmetric and counter-cyclical behavior for Markov switching model.