The Central Bank of Latvia has published a working paper analysing how macroeconomic and budget balance shocks affect public debt trajectories in the euro area, using country-specific structural vector autoregression models and panel local projections to estimate impulse responses. The paper finds that a positive GDP shock persistently reduces the debt-to-GDP ratio, while a positive GDP deflator shock lowers it 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 approximate one-year lag. The analysis also reports state-dependent and non-linear effects, including stronger debt-reduction effects of fiscal austerity after expansions than after recessions and when initial debt is low rather than high, alongside evidence that larger fiscal shocks generate more persistent and statistically significant debt responses.
Central Bank of Latvia 2025-10-14
Central Bank of Latvia publishes research on how macroeconomic and fiscal shocks shape euro area public debt paths
The Central Bank of Latvia released a working paper examining the impact of macroeconomic and budget balance shocks on public debt trajectories in the euro area. The study finds that GDP and GDP deflator shocks reduce the debt-to-GDP ratio, while interest rate shocks increase it. Fiscal austerity measures significantly lower the debt ratio, with effects varying based on economic conditions and initial debt levels.