Stochastic debt simulation using VAR models and a panel fiscal reaction function : results for a selected number of countries

This paper uses vector auto-regression (VAR) models and a panel fiscal reaction function (FRF) to simulate debt ratios for fifteen EU Member States according to four regimes which are the Cartesian product of two types of errors (normal or bootstrapped) with two alternative assumptions on the (structural) primary balance (unchanged at the last observed value or endogenously determined using a panel FRF). Results suggest that debt ratio paths are not normally distributed being positively skewed; and that primary balances show "fiscal fatigue" and partial mean reversion to historical trends. It is suggested that debt sustainability scenarios should also be run using a FRF or some equivalent "mean reversion" hypothesis.