Sustainability of Public Debt in Europe: The Use of Swaps

Abstract

This study contributes to the literature on public debt sustainability and investigates whether European
countries manage primary surplus also through interest rate swaps. Since the 1990s European countries
have extensively employed Over The Counter (OTC) contracts such as swaps to smooth the financial
costs of debt, shift part of debt forward, and exploit the lack of accounting transparency of these
contracts. One of the primary goals of the EU fiscal framework is to ensure public debt sustainability.
Several proposals have been considered to improve the current framework, yet none of them has
addressed the issue of debt sustainability when countries use swaps. This is the first empirical
investigation that confirms the use of swaps by European countries in the 2006-2018 period to improve
the primary balance. According to panel data results, EU countries increased the primary surplus in the
2006-2018 period following a rising debt and took corrective action by actively managing their debt with
swaps; this evidence is in line with the hypothesis of the strategic use of swaps by public administrations
widely described in the theoretical literature on debt management. Policy implications and proposals to
improve the current European fiscal framework are provided.