The Central Bank of Latvia published a working paper assessing how macroeconomic shocks and budget balance shocks shape public debt paths across the euro area, using country-specific structural vector autoregression models and panel local projection methods to estimate impulse responses. The analysis finds that a positive GDP shock produces a persistent decline in the debt-to-GDP ratio, while a positive GDP deflator shock lowers the debt ratio only temporarily. By contrast, a positive interest rate shock leads to a substantial and lasting increase in the debt ratio. A positive primary balance shock, interpreted as discretionary austerity, reduces the debt ratio significantly but with an estimated lag of around one year. The paper also reports state-dependent and non-linear effects: austerity is more effective after periods of economic expansion than after recessions and when initial public debt is low rather than high; GDP shocks reduce the debt stock more when the debt stock is initially large; and the debt response to a positive budget balance shock is more persistent and statistically significant when the shock is large.
Central Bank of Latvia working paper examines how macroeconomic and fiscal shocks affect euro area public debt trajectories
The Central Bank of Latvia released a working paper analyzing the impact of macroeconomic and budget balance shocks on public debt in the euro area. Key findings include that GDP shocks reduce the debt-to-GDP ratio, while interest rate shocks increase it. Austerity measures are more effective post-expansion and when initial debt is low.