Journal of Economic Perspectives
ISSN 0895-3309 (Print) | ISSN 1944-7965 (Online)
Sovereign Debt and Fiscal Integration in the European Union
Journal of Economic Perspectives
(pp. 49–74)
(Complimentary)
Abstract
This paper examines sovereign debt risks in the European Union, which has centralized monetary policy within the euro area, while fiscal policies remain national. Institutional reforms, including common banking supervision, the European Stability Mechanism, the European Central Bank's market-stabilisation instruments, and a new set of fiscal rules, have mitigated vulnerabilities arising from the interdependence between banks and sovereigns. Stochastic debt sustainability analysis suggests that debt remains sustainable in most EU countries, although substantial fiscal adjustments will be required in some cases. Fiscal reaction function estimates, however, reveal a weakening policy response to rising debt, signalling increased medium-term risks. The paper argues that further adaptation of fiscal rules is needed to encourage investment and provide greater flexibility for low-risk countries. Expanding the pool of common EU safe assets could also help break the bank-sovereign doom-loop, attract foreign investors, and strengthen fiscal sustainability.Citation
Darvas, Zsolt, Lennard Welslau, and Jeromin Zettelmeyer. 2025. "Sovereign Debt and Fiscal Integration in the European Union." Journal of Economic Perspectives 39 (4): 49–74. DOI: 10.1257/jep.20251451Additional Materials
JEL Classification
- E23 Macroeconomics: Production
- E31 Price Level; Inflation; Deflation
- E58 Central Banks and Their Policies
- E62 Fiscal Policy
- F33 International Monetary Arrangements and Institutions
- G21 Banks; Depository Institutions; Micro Finance Institutions; Mortgages
- H63 National Debt; Debt Management; Sovereign Debt