Fiscal risk and public sector balance sheets

Abstract

The sovereign debt crisis in the euro area has shown that sovereign default risk can be a serious issue also in advanced economies. We use a difference-in-difference approach to identify the factors that lead to the crisis in the euro area. We find that, the global financial crisis of 2008-09, which hit all euro-area countries, uncovered persistent weaknesses in some countries. In others, which started from a seemingly strong fiscal position, the crisis was triggered by a strong decline in revenues. Responding to the incipient recession with structural rather than cyclical measures also contributed to the emergence of a debt crisis. We then discuss the use of advanced statistical methods to evaluate fiscal sustainability. One approach is the estimation of fiscal limits and fiscal space, the other the construction of government balance sheets using a model-based approach to the valuation of government assets and liabilities. We show that the two approaches are closely related. We suggest that the use of such approaches can help governments to identify fiscal risks and improve fiscal transparency. In Europe, this could be a useful activity of the newly created fiscal councils.

The ADEMU Working Paper Series is being supported by the European Commission Horizon 2020 European Union funding for Research & Innovation, grant agreement No 649396.