Conditional Forecast for Public Debt and Threshold Effects: Evidence from South EU Countries

Abstract

In this study, we employ a Bayesian Seemingly Unrelated regression (SUR) model for the South EU countries to make a conditional forecast for the public debt in a medium term-horizon (six years ahead). Our forecast is based on multiple shocks such as fiscal austerity, the international business cycle and energy cost expressed by US GDP growth and oil price respectively. Adopting various scenarios, the results show that lower budget deficit and higher economic growth lead to the fastest downward debt trajectory. The findings also suggest that the optimum level of the fiscal limit is 2.7% and is achieved when government expenditures and revenue are lower than 40.9% and 38.19% respectively. Interestingly, the international business cycle plays a fundamental role, since economic growth of the South EU countries exerts even more pressure to debt reduction when US GDP growth is higher than 3%. The effect of inflation on debt conditioned by energy cost, the results indicate that inflation may cause more debt when oil price is high, but this effect seems to be for a short-term period. The main policy implication from the results is that the downward trajectory of debt continues to hinge crucially on prudent fiscal policy and economic growth   Keywords: Bayesian prediction, Public debt, Budget deficit, Panel thresholds. JEL Classification: H60, H61, H62, H63, H68

Keywords: Bayesian prediction, Public debt, Budget deficit, Panel thresholds.JEL Classification: H60, H61, H62, H63, H68