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This paper analyses the short- and medium-term effects of high inflation on fiscal developments in Croatia. The main analytical novelty is to add inflation shocks to the fiscal reaction function, an approach that was not considered in macro-fiscal research during the long period of moderate inflation. Our results suggest that inflation has a favourable effect on the primary balance in the short term, which can be explained by the positive effect of inflation on nominal tax revenues and an initial lagged adjustment of public expenditure to inflation. In the medium term, however, inflation is likely to have a negative effect on the primary balance by raising government expenditure more than tax revenues.

We investigate the impact of fiscal stimuli at different levels of the government debt-to-GDP ratio for a sample of 17 European countries from 1970 to 2010. This is implemented in an interacted panel VAR framework in which all coefficient parameters are allowed to change continuously with the debt-to-GDP ratio. We find that responses to government spending shocks exhibit strong nonlinear behavior. While the overall cumulative effect of a spending shock on real GDP is positive and significant at moderate debt-to-GDP ratios, this effect turns negative as the ratio increases. The total cumulative effect on the trade balance as a share of GDP is negative at first but switches sign at higher levels of debt. Consequently, depending on the degree of public indebtedness, our results accommodate long-run fiscal multipliers that are greater and smaller than one or even negative as well as twin deficit and twin divergence behavior within one sample and time period. From a policy perspective, these results lend additional support to increased prudence at high public debt ratios because the effectiveness of fiscal stimuli to boost economic activity or resolve external imbalances may not be guaranteed.

This article develops an analytical method and metric for evaluating the extent to which a nation’s budget support commercial debt is increased by the obligation to repay concessional project loans of the past. This is dubbed as the Peter-Paul problem. Applying it to the case of Sri Lanka and global experiences provides two kinds of insights: the hidden possibility and sources of designated project loans driving a national debt crisis, and key considerations for multilateral practices in lending to and graduating countries from concessional debt.

In contrast to sub-Saharan Africa, Cape Verde’s public debt increased sharply following the 2008-09 crisis. This paper evaluates whether there was a pro-cyclical bias in the recent debt dynamics of Cape Verde. Using data between 2001 and 2019, we construct detailed records on the dynamics of public debt and its composition and then compute primary structural public deficits by estimating cyclical elasticities of the budget balance to assess the fiscal policy stance. Further, by comparing the estimated fiscal stance with the cycle phase, this study assesses whether fiscal policy evidences pro-cyclical bias. The study concludes that structural primary deficits, adequately counter-cyclical, were the main determinants of Cape Verde’s recent public debt increase. Expansionary pro-cyclical fiscal policy was only implemented in 2006, 2008, and 2019, and the most crucial episode, in 2008, strongly resulted from public investment efforts. Thus, debt correction may be easy to perform since deficit bias is, apparently, not political-cycle driven.

An on-going period of secular stagnation in advanced economies has brought down interest rates, growth rates and inflation. Due to the relatively larger fall in interest rates, the differential between the interest rate paid on government debt and the output growth rate (IRGD) became lower and has even turned negative in most advanced economies. In such an environment, public debt may come at much lower (or even no) cost. Thus, if this pattern remains stable, it has important implications on the role of fiscal policy. Against this background, this paper discusses relevant long-term trends in Europe and aims to explain the currently low IRGD. Furthermore, it investigates possible future IRGD paths and its consequences for fiscal policy.

Climate change poses a significant challenge for Latin America and the Caribbean, exposing its vulnerabilities to hydrometeorological shifts and rising temperatures that threaten economic stability. We examine the macroeconomic consequences of climate change through the lens of six distinctive country cases. Our results suggest that compensating for the drag on economic growth caused by climate change would require public and private investments of 5.3 % of GDP to 10.9 % of GDP per year. Faced with existing fiscal constraints and restrictive financial conditions, we explore the macrofiscal implications of an investment push in line with the Nationally Determined Contributions (NDCs). Our results suggest that front-loaded public adaptation investments would improve growth over the medium term, although not fully compensating for climate losses. However, resulting public debt trajectories would become untenable in most countries. We find that a key factor for a fiscally sustainable NDC investment push is the financial costs that countries face when issuing sovereign debt. Debt sustainability could be significantly improved if countries could finance their climate investments at lower cost or concessional terms.

This paper presents a simple heuristic measure of tail risk, which is applied to individual bank stress tests and to public debt. Stress testing can be seen as a first order test of the level of potential negative outcomes in response to tail shocks. However, the results of stress testing can be misleading in the presence of model error and the uncertainty attending parameters and their estimation. The heuristic can be seen as a second order stress test to detect nonlinearities in the tails that can lead to fragility, i.e., provide additional information on the robustness of stress tests. It also shows how the measure can be used to assess the robustness of public debt forecasts, an important issue in many countries. The heuristic measure outlined here can be used in a variety of situations to ascertain an ordinal ranking of fragility to tail risks.

This paper investigates the dynamic stability of public debt and its solvency condition in the face of crisis periods (1980–2021) in a sample of 11 euro-area countries. The focus is on the feedback loop between the dynamic stability of public debt and interest rates, discounted by economic growth, in conjunction with budget deficits during tranquil and turbulent periods. Using the GMM panel dynamic model, the results show that dynamic stability was the case before the global financial crisis (GFC), while from GFC to the pandemic, dynamic instability prevailed and persisted in the evolution of public debt. Furthermore, panel threshold estimates show that dynamic instability of debt starts to violate the solvency condition when the borrowing cost is above 3.29%, becomes even stronger when it is above 4.39%, and exerts even more pressure when the level of debt is greater than 91%. However, the debt sustainability condition reverses course when economic growth is higher than 3.4%. The main policy implication drawn from the results is that low interest rates can create a self-reinforcing loop of high debt, which itself is a serious matter for public authorities when designing economic policies.

The objective of this research was to demonstrate the (nonlinear) risks of sovereign insolvency and explore the applicability of stochastic modeling in public debt management, given a structural economic model of stochastic government debt dynamics. A stochastic optimal control model was developed to model public debt dynamics based on the debt accounting identity, where the interest-growth differential obeys a continuous random process. This stochasticity represents both the interest rate risk of public debt and the variability of the growth rate of the nominal Gross Domestic Product combined. The optimal fiscal policy was analyzed in terms of the model parameters. The model was simulated, and results were visualized. The insolvency risk was demonstrated by examining the variance of the optimal process. The model was amended with hidden credit risk premia and fiscal multipliers, which forces the debt dynamics to be nonlinear in the debt ratio. The results, on the other hand, confirm that the volatility of the interest-growth differential is crucial in terms of sovereign solvency and in addition, it demonstrates the large risks stemming from the multiplier effect, which underlines the need for prudent debt management and fiscal policy.