Geopolitical Shocks, Fiscal Dominance, and the TPI Conditionality: A Structural Conflict in the Euro Area

Le Roux, Thomas (2025): Geopolitical Shocks, Fiscal Dominance, and the TPI Conditionality: A Structural Conflict in the Euro Area.

Abstract

Abstract This paper argues that the dominant risk to Euro Area stability has structurally shifted from cyclical inflation to a direct conflict between geopolitically-driven fiscal policy and central bank independence. We construct a novel quarterly dataset of exogenous geopolitical fiscal shocks (GEO_SHOCK) using a narrative approach (Ramey, 2011). A Structural Vector Autoregression (SVAR) for the EA aggregate finds these shocks are persistently inflationary, with a peak impact of +0.08% on the HICP. A Panel SVAR, robust to local projections, finds the shocks drive significant fragmentation: a 1-std-dev shock widens spreads in high-debt (90th percentile) member states by 22 basis points, an effect absent in pandemic-related fiscal shocks. The shock accounts for 34% of medium-term spread variance. A high-frequency event study confirms this, showing an immediate +11.2 bps impact on Italian spreads post-announcement. A counterfactual simulation shows that a TPI "spread cap" would stabilize debt but amplify inflation, quantifying the fiscal dominance trade-off.

• Item Type: MPRA Paper
• Language: English
• Keywords: Fiscal Dominance, Monetary Policy, Geopolitical Risk, TPI, Fragmentation, SVAR, Local Projections
• Subjects: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E62 - Fiscal Policy; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E63 - Comparative or Joint Analysis of Fiscal and Monetary Policy ; Stabilization ; Treasury Policy; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F45 - Macroeconomic Issues of Monetary Unions; H - Public Economics > H6 - National Budget, Deficit, and Debt > H63 - Debt ; Debt Management ; Sovereign Debt

References

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