Asymmetries in the sustainability of public debt in the EU: The use of swaps

The aim of this paper is to analyze the effects of structural asymmetries related to the use of interest rate swaps within the European Union (EU) on the sustainability of public debt. The fiscal consolidation required to comply with the European budgetary rules increased for some countries the incentives to use debt related instruments (i.e., financialization of debt). Indeed, in the period 2006–2020, 17 EU countries used interest rate swaps to hedge their public debt. Dynamic panel data analysis results show that a 1 percent increase in the ratio of interest rate swaps to debt, ceteris paribus, leads to an improvement of the primary surplus over GDP by 0.49, thus ameliorating the sustainability of public debt. However, financial contracts imply additional risks that can ultimately impact in the medium term on public debt, which are not currently assessed by the standard Debt Sustainability Analysis (DSA). The aim of the paper is to fill this gap and discuss the main policy implications of the use of swap. In the post pandemic era, the political economy of debt reduction should properly consider the financial risks related to swaps.