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Economic consequences of high public debt and challenges ahead for the euro area
E43 - Determination of Interest Rates; Term Structure of Interest Rates
E62 - Fiscal Policy; Public Expenditures, Investment, and Finance; Taxation
H63 - Debt; Debt Management
O40 - General
The aim of this paper is to reflect on the economic consequences of high public debt and the challenges ahead for the euro area. The paper reviews the economic risks associated with regimes of high public debt through DSGE model simulations and stresses the need for comprehensive solutions to mitigate such risks in the future. While the large public debt build-up following the global financial and economic crisis acted as a shock absorber for output, keeping public debt at high levels is a source of vulnerability in itself, particularly given the arising fiscal and economic pressures from ageing. Moreover, in the euro area, where monetary policy focuses on the area-wide aggregate, countries with high levels of indebtedness are poorly equipped to withstand asymmetric shocks. Looking at the historical evidence, the paper reviews the menu of tools at hand for euro area governments to further reduce their debt ratios. It posits that the urgency of efforts in this respect depends on risks to public debt sustainability. In the context of the broader reform agenda on how to strengthen EMU resilience, the paper acts as a reminder that further risk reduction and institutional reform is needed.