Sovereign debt sustainability in the Euro Area: a probabilistic assessment

This paper assesses sovereign debt sustainability in the euro area using a model-free, data-driven approach. We estimate a panel Vector Autoregression (VAR) to model the joint dynamics of key fiscal and macroeconomic variables, and simulate future trajectories to compute the probability that each country can sustain its current debt level. The methodology avoids strong assumptions on structural relationships or future fiscal behavior. The results show significant variation in sustainability risks among countries, with high-debt nations such as Italy and Greece having much lower sustainability probabilities compared to core euro area economies. Interestingly, the study divides public debt simulations into those where sustainability is facilitated by favorable growth-adjusted interest rates from those where the future positive surpluses drive debt repayment even discounted at a positive rate. These findings underscore the importance of credible fiscal frameworks and coordinated policy support to maintain debt sustainability in a low-growth, high-rate environment.