Unpleasant debt dynamics: Can fiscal consolidations raise debt ratios?

Using PESSOA, a medium-scale DSGE model for a small euro-area economy, we evaluate how scal adjustments impact short- and medium-term debt dynamics and output for alternative policy options, and budgetary and economic conditions. Fiscal djustments may increase the public debt-to-GDP ratio in the short run, even forconsolidations carried out in normal times in economies characterized by moderateindebtedness levels. Financial turmoils and hikes in the nationwide risk premia, coupledwith high indebtedness levels and sti scal measures, boost the output costs ofscal consolidations and severely aect their eectiveness in bringing the public debtto-GDP ratio down in the short term. In the medium run credible scal adjustments entail a decline in the public debt ratio, though at potentially very large output losseswhen carried out under unfavorable budgetary and economic conditions.