The importance of government fiscal policies on debt, and their potential impact on financial stability and systemic risk

Abstract

This thesis explores the relationship between fiscal policies, sovereign debt, and systemic financial risks in Western economies, focusing on comparing case studies of Mediterranean countries like Greece, Italy, and Spain, and Northern European nations such as Germany, the Netherlands, and Finland. It examines how institutional frameworks, such as Germany’s "debt brake" and the Netherlands’ trend-based budgeting, promote fiscal discipline and economic resilience. In contrast, weaker governance in Mediterranean countries has led to unsustainable debt levels and increased systemic risks. The research highlights the damaging effects of austerity measures in Greece, which increased economic contractions and social unrest, compared to Germany’s countercyclical policies that stabilized growth without increasing debt. Spain’s mixed approach of labour reforms and stimulus illustrates the need for tailored strategies during crises. The study also investigates systemic risks from sovereign-banks, showing how Northern Europe’s diversified banking systems avoided the "doom loops" that destabilized Mediterranean economies. Additionally, it emphasizes the importance of proactive reforms to address long-term challenges like aging populations, as seen in Germany’s linkage of retirement ages to life expectancy. The thesis advocates for greater EU fiscal coordination, including proposals like a European Debt Agency to manage sovereign debt collectively and reduce market disparities. By creating these insights, the research provides recommendations for balancing fiscal discipline with economic flexibility while safeguarding financial stability in an interconnected global economy.