DATA AND PRELIMINARY RESULTS 1 The data

The analysis is based on a panel of 33 countries (all EU countries except CY, LU and MT, and other nine advanced economies.)(105) Data come from AMECO, the IMF's World Economic Outlook (WEO) and the Bank for International Settlements. Table IV.3.1 report the source and descriptive statistics of each series used.

Whenever possible we used time series covering the period 1970-2010 but for a number of variables data are only available starting from 1995. Data for 2010 or 2009-10 were extrapolated for some variables for which observations were missing.(106)

(104_{) For the time being we have constructed a single composite}

indicator for financial-competitiveness variables given the limited number of competitiveness variables we currently have. Distinguishing between the two would anyway be preferable, depending on a sufficient number of variables becoming available.

(105) CY, LU and MT are excluded from the sample as we currently miss the necessary information on recorded fiscal crisis events over the past four decades. The other 9 advanced economies included in the analysis are: Australia, Canada, Iceland, Israel, Japan, New Zealand, Norway, Switzerland, US.

(106_{) If both 2009 and 2010 values were missing, and if the}

variable represented a net stock or flow of financial assets or a net saving rate, then these two missing values were set equal to the 2008 value. If 2010 only was missing, it was set equal to the average of the previous 3 years (except for the stock or flow of financial assets for which the 2009

Part IV Debt sustainability in the EU

The identification of fiscal crisis events over the time interval 1970-2010 is borrowed from Baldacci et al. (as already said, slightly revised to account for the different application of the

value was taken.) These assumptions practically do not affect the optimal thresholds when using a one-year signalling window as the 2010 values of the variables do not enter into the computation.

inflation rate criterion.)(107) The sample contains 143 fiscal crisis years regrouped in 54 episodes, leading to an average duration of about 3 years for each crisis episode. There are however 21 one-year episodes. The number of countries (per year)

(107_{) As specified in Baldacci et al. (2011), data on debt default}

and restructuring were obtained from S&P; information on exceptional IMF-supported programmes comes from the IMF's Finance Department database; data on sovereign bond yields at annual and monthly frequencies were obtained from IMF's International Financial Statistics (IFS), Bloomberg and Datastream.

Table IV.3.1: Descriptive statistics and sources

variable mean sd min p10 median p90 max no. obs source

AMECO, WEO AMECO, WEO AMECO, WEO AMECO, WEO AMECO, WEO AMECO, WEO

Short-term debt, gov't, % GDP 10.1 8.7 0 2.3 7.7 22.4 54 548 BIS

Net debt, % GDP 28.4 49.4 -208.4 -13.9 35.7 82.9 119.3 586 WEO

AMECO, WEO AMECO,

WEO

Change in final consumption

expenditure of gen. gov't, % GDP 0.2 1 -7.9 -0.7 0.1 1.2 7.2 906 AMECO Net financial assets, total economy, %

GDP -24.1 38.5 -174.8 -77.4 -17.7 18.4 74.5 342 AMECO

Net savings of households, % GDP 4 4.8 -16.3 -1.6 4.1 8.6 22.2 591 AMECO

Net savings of non-financial

corporations, % GDP 3.7 3.7 -7.6 -0.4 3.5 7.8 35.4 551 AMECO

Private sector debt, % GDP 113.6 63.1 2.3 35.6 117.6 202.3 331.6 335 EUROSTAT AMECO,

WEO

Leverage, financial corporations 6.2 3.5 1.6 3.1 5 10.8 21.3 344 AMECO

Short-term debt, non-financial corp., %

GDP 1.6 1.8 0 0.1 1.2 3.3 13.2 327 BIS

Real short-term interest rate 2.1 3.9 -23.3 -2 2.2 6.3 20.1 833 AMECO

Construction, % value added 6.6 1.6 2.7 4.8 6.5 8.8 13.5 1010 AMECO

Current account, % GDP -1.5 5.5 -26.9 -7.8 -1.4 4.5 17.9 912 WEO

Avg growth rate of real effective exchange rate, based on exports deflator, ref 35 countries

1.3 3 -5.9 -1.9 0.9 5 13.1 372 AMECO

Average growth rate of nominal unit

labour costs over last 3 years 7.6 14.9 -3.4 0.4 4 16.1 204 892 AMECO

Real GDP growth 2.6 3.6 -32.1 -0.8 3 6.2 13.1 1041 AMECO

GDP per capita in PPP, % of US level 69.4 22 16.2 33.2 74.9 91.5 129.3 1073 AMECO EUROSTAT, AWG project. OECD, WHO ESSPROS, AWG project. Balance, % GDP -2.4 4.3 -30.9 -7.5 -2.6 2.5 19.1 1021 Primary balance, % GDP 1.1 3.8 -28.2 -3.2 0.7 5.6 20.6 998

Cyclically adjusted balance, % GDP -2.9 3.5 -15.2 -7.4 -2.9 1.5 8.7 830

Stabilizing primary balance, % GDP 0 2.7 -19.1 -3 0 3.1 16.4 854

Gross debt, % GDP 51.5 30.1 3.7 16.4 48.4 93.5 217.6 945

Change in gross debt, % GDP 1 4.8 -25.5 -3.9 0.4 6.2 41.7 912

Interest rate-growth rate differential -1.8 7.9 -74.7 -11 0 5.1 25.2 833

Change in expenditure of gen. gov't, %

GDP 0.3 2.4 -20.8 -1.9 0.2 2.9 15.5 960

Net acquisition of financial assets,

private sector, % GDP 14.8 8.4 -4.1 5.5 13.5 23.9 58.8 334

Old-age dependency ratio 20 years

ahead 25.7 5.8 15.4 18.2 24.8 33.9 44.7 1041

Avg yearly change in projected age- related public expenditure as % of GDP

over next 30 years

0.1 0.1 -0.1 0 0.1 0.2 0.3 373

Note: 2010 values are excluded from the descriptive statistics as they are not used to compute the thresholds.

European Commission Public finances in EMU - 2011

158

experiencing a fiscal crisis is reported in Graph IV.3.1. Graph IV.3.2 below provides the same information separately for the four components of the fiscal crisis definition.

3.4.2. Preliminary results

Preliminary results are reported in Table IV.3.2 for 1) the individual variables; 2) the two composite indicators constructed using respectively only fiscal and financial-competitiveness variables; and 3) the overall composite indicator. The Table reports the threshold obtained by applying the methodology, together with the indication of the interval (above/below the threshold) where values of the variable would indicate no fiscal crisis risks; the type I and type II errors (i.e. respectively the number of crisis signals sent ahead of no crisis over the total number of non-crises and the number of no-crisis signals sent ahead of crises over the total number of crises, based on past behaviour;) the signalling power of the variable,(108) which provides a measure of the variable's reliability as a fiscal crisis predictor; the number of crisis and non-crisis events entering the computation of the threshold.(109)

(108_{) The signalling power is given by 1-(type I error + type 2}

error). See Box IV.3.2 for details.

(109_{) The number of crisis and non-crisis events in Table IV.3.2}

differs by variable depending on data availability (for variables for which longer time series are available the calculation of the threshold can be based on a larger number of past crisis and non-crisis events).

For the overall composite indicator, a threshold of 0.45 is obtained, meaning that for values at t

greater than 0.45 a fiscal crisis would be signalled for t+1. Corresponding to this threshold, the indicator would have signalled a crisis when instead no crisis was looming ahead (type I error) for 17% of past non-crisis events, while it would have signalled no crisis ahead of a crisis (type II error) for 27% of past crisis events. Equivalently, the indicator would have properly identified 73% of past crisis events and 83% of past non-crisis events, highlighting quite a good overall performance for this type of methodology (110) (reflected in the relatively high signalling power of 0.56.) Positive is also the fact that the indicator displays a relatively good performance at not missing crises (the predictive error entailing more serious consequences between the two.)

(110_{) As indicated in the relevant literature, non-negligible}

predictive errors are typically recorded with early warning system methodologies. The size of the errors reported in Table IV.3.2 are in line with findings in other studies. See Baldacci et al. (2011) and Hemming et al. (2003).

Graph IV.3.1: Number of countries in the sample experiencing a fiscal crisis, 1970-2010

0 2 4 6 8 10 12 14 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Part IV Debt sustainability in the EU

Results in Table IV.3.2 show that the financial- competitiveness index has a better performance at predicting fiscal crises than the fiscal index (a signalling power of 0.52 against 0.22.) Overall, financial-competitiveness variables seem to be better "leading indicators" for fiscal crises than fiscal variables are, when relying on 1-year ahead crisis signals.

With regard to individual variables, all thresholds reported in Table IV.3.2 are "meaningful" in the sense of lying in the crisis-prone tail of the respective variables' distributions. For instance, the variable gross debt over GDP would send crisis signals for values greater than 103% and the change in gross debt over GDP for values greater than 6.6%.

Among the fiscal variables, the primary balance and the cyclically adjusted balance over GDP turn

out to be the best predictors of fiscal crises, displaying some of the highest signalling powers (0.12 to 0.25) and the lowest rates of missed crises (32 to 43%.) Net debt, the change in gross debt over GDP, the change in general government final consumption expenditure over GDP, the projected old-age dependency ratio and the change in projected age-related public expenditure over GDP also display higher signalling powers in relative terms, though accompanied by higher rates of missed crises (all above 60%.)

Graph IV.3.2: Number of countries in the sample in default or restructuring, under IMF-supported programmes, experiencing high inflation rates or bond yield pressure, 1970-2010

0 2 4 6 8 10 12 197 0 197 2 197 4 197 6 1978 198 0 198 2 198 4 198 6 1988 199 0 1992 199 4 1996 199 8 2000 200 2 200 4 2006 200 8 2010

Default or restructuring IMF-supported programme

0 2 4 6 8 10 12 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

High inflation Bond yield pressure

European Commission Public finances in EMU - 2011

160

Among the financial variables, best predictors of fiscal crises are the net financial assets of the total economy over GDP, the net savings of households over GDP, the private sector debt over GDP and the leverage of financial corporations (signalling powers between 0.2 and 0.65 and rates of missed crises between 8 and 30%.) Among the competitiveness variables, the current account over GDP, the average growth rate of the real effective exchange rate and of nominal unit labour costs perform all well (signalling powers between 0.22 and 0.41 and rate of missed crises between 14 and 47%.) Construction as a share of value added and the level of GDP per capita in PPP (as % of US level) also have a good performance in terms of signalling power (0.26-0.27) as well as in terms of rate of missed crises (25 and 32% respectively.)(111)

(111_{) The good performance of most of these financial and}

competitiveness variables could be expected based on the

In general terms, and as one would expect, results in Table IV.3.2 show that the joint consideration of all these variables combined into a composite indicator tends to provide better results in terms of event study analysis that shows a statistically significant difference in behaviour for a number of them on the eve of a fiscal crisis. The analysis is not presented here because it would be partly redundant. Based on it, fiscal variables do