Sustainability of Local Government Sector Debt. Evidence from Monte-Carlo Simulations

  • Krzysztof Kluza Warsaw School of Economics (SGH), Department of Quantitative Economics, Madalinskiego 6/8 Street, 02-513 Warsaw
Keywords: local government, debt sustainability, interest rate increase, Monte Carlo method


The financial standing of local governments across the European Union was strongly affected by the economic crisis. The local government sector conducted vast investment policies reaching 10.2% of all investments in the EU countries in 2010. However, at the same time its indebtedness expanded significantly. The current low interest rate environment makes the sector vulnerable to future interest rate increases. The presented research analyses the impact of several scenarios of interest rate changes in Poland on the local governments’ ability to service their current debt burdens. Simulations are conducted with the Monte Carlo method. Some scenarios indicate a high vulnerability of local governments to adverse changes in market interest rates, but only if they are combined with a reduction of sector’s operating surplus. Such an economic setup may give rise to systemic problems for the whole public sector.

Author Biography

Krzysztof Kluza, Warsaw School of Economics (SGH), Department of Quantitative Economics, Madalinskiego 6/8 Street, 02-513 Warsaw
Adjunct Professor


Balassone F., Cunha J., Langenus G., Manzke B., Pavot J., Prammer D. & Tommasino P. (2011) Fiscal sustainability and policy implications: a post-crisis analysis for the euro area, International Journal of Sustainable Economy, 3(2), pp. 210-234.
Bank for International Settlements (BIS) (2011) Basel III: A global regulatory framework for more resilient banks and banking systems (Basel: Basel Committee on Banking Supervision).
Bank for International Settlements (BIS) (2009) Principles for sound stress testing practices and supervision (Basel: Basel Committee on Banking Supervision).
Barrell R., Holland D. & Hurst I. (2012) Fiscal Consolidation: Part 2. Fiscal Multipliers and Fiscal Consolidations, OECD Economics Department Working Papers, OECD Publishing, No. 933 (Paris: OECD).
Białas M. (2012) Wykorzystanie symulacji Monte Carlo do wyceny przedsiębiorstwa metodą APV, Zarządzanie i Finanse, 4(1), pp. 23-35.
Ghosh A., Kim J., Mendoza E., Ostry J. & Qureshi M. (2013) Fiscal Fatigue, Fiscal Space and Debt Sustainability in Advanced Economies, The Economic Journal, 123(February), pp. f4-f30.
Hendry D. (1984) Monte Carlo experimentation in econometrics, In: Griliches, Z. & Intriligator, M. D. (eds) Handbook of Econometrics, vol. II (Amsterdam: Elsevier Science Publishers BV), pp. 937-976.
Chyliński A. (1999) Metoda Monte Carlo w bankowości (Warszawa: Twigger SA).
Cline W. (2012a) Interest Rate Shock and Sustainability of Italy’s Sovereign Debt, Policy Brief (Washington, D.C.: Peterson Institute for International Economics).
Cline W. (2012b) Sovereign Debt Sustainability in Italy and Spain: A Probabilistic Approach, Working Paper Series (Washington, D.C: Peterson Institute for International Economics).
Cline W. (2013) Debt Restructuring and Economic Prospects in Greece, Policy Brief (Washington, D.C: Peterson Institute for International Economics).
Donald B., Glasmeier A., Gray M. & Lobao L. (2014) Austerity in the city: economic crisis and urban service decline?, Cambridge Journal of Regions, Economy and Society, 7(1), pp. 3-15.
Eggertsson B. & Krugman P. (2012) Debt, Deleveraging and the Liquidity Trap: a Fisher-Minsky-Koo Approach, The Quarterly Journal of Economics, 127(3), pp. 1469-1513.
Eller M. & Urvova J. (2012) How Sustainable Are Public Debt Levels in Emerging Europe?. Evidence for Selected CE SEE Countries from a Stochastic Debt Sustainability Analysis, Focus on European Economic Integration, Q4/2012, pp. 48-79.
International Monetary Fund (IMF) (2013) Greece, IMF Country Report, No. 13/20 (Washington, D.C: International Monetary Found).
Jajuga K. (ed.) (2009) Zarządzanie ryzykiem (Warszawa: PWN).
Kelliher C. F. & Mahoney, L. S. (2000) Using Monte Carlo simulation to improve long-term investment decisions, The Appraisal Journal, 68(1), pp. 44-56.
Kluza, K. (2014) Impact of the economic slowdown on local government investments, debt and productivity in the EU countries, Journal of Economics and Management, 18, pp. 26-39.
Kluza, K. (2015) Changes in credit risk profile of Polish local governments. Assessment of unsystematic risk, XVIIth conference Financial Investments and Insurance Wroclaw, Poland, September 17-19, 2014.
Medeiros J. (2012) Stochastic debt simulation using VAR models and a panel fiscal reaction function – results for a selected number of countries, European Economy, Economic Papers 459 | July (Brussels: European Commission).
Metropolis N. & Ulam S. (1949) The Monte Carlo Method, Journal of the American Statistical Association, 44(247), pp. 335-341.
Niemiro W. (2013) Symulacje stochastyczne i metody Monte Carlo (Warsaw: University of Warsaw).
Palepu K., Healy P. & Bernard V. (2004) Business Analysis and Valuation: Using Financial Statements, Text and Cases [chapters: Financial Analysis and Credit Analysis and Distress Prediction], 3rd Edition (Mason: Thomson Southwestern).
Pawlak M. (2012) Symulacja Monte Carlo w analizie ryzyka projektów inwestycyjnych, Zeszyty Naukowe Uniwersytetu Szczecińskiego, 690, pp. 83-94.
Peck J. (2014) Pushing austerity: state failure, municipal bankruptcy and the crises of fiscal federalism in the USA, Cambridge Journal of Regions, Economy and Society, 7(1), 17-44.
Peterson G. (1998) Measuring Local Government Credit Risk and Improving Creditworthiness (Washington D.C: The World Bank).
Vammalle C. & Hulbert C. (2013) Sub-national Finances and Fiscal Consolidation: Walking on Thin Ice, OECD Regional Development Working Papers, OECD, 2013/02, (Paris: OECD).
Vasilopoulos C. (2013) Financial Stress Testing. A model based exploration under deep uncertainty, PhD Dissertation (Delft: Delft University of Technology).
Yeh CP., Hsu AC., Hsien W. & Chai KC. (2014) Neural Network Forecasts of Taiwan Bureau of National Health Insurance Expenditures, The International Journal of Business and Finance Research, 8(5), pp 95-114.