A Complementary Tool to Monitor Fiscal Stress in European Economies

Summary:

This paper presents an indicator of fiscal distress for European economies based on a multivariate regression analysis (logit modelling, the L1 indicator) and on a recently updated dataset of fiscal stress episodes. This indicator presents some interesting features: relying on a parsimonious set of variables that have been tested for their conditional statistical significance, it exhibits an overall satisfactory in sample performance. In line with Berti et al. (2012), this indicator confirms the importance of monitoring macro-financial variables to assess countries' vulnerabilities to fiscal distress. It also provides some evidence that the change in the public debt ratio is an important predictor of fiscal distress events, while the level of public debt would particularly matter when combined with macro competitiveness imbalances. Our analysis suggests that the L1 indicator could be used as a complementary tool to the Commission S0 indicator to monitor prospective fiscal risks, building on the respective strengths of the two approaches, while compensating for their limitations.

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