The Impact of Budget Deficit on Poland's Public Debt – An Analysis of Long-Term Dependencies

Streszczenie

Niniejsza praca podejmuje problematykę długookresowych zależności między deficytem budżetowym a długiem publicznym Polski w latach 1990–2023. Celem badania jest ustalenie charakteru tych zależności oraz ocena instytucjonalnych i strukturalnych uwarunkowań stabilności fiskalnej. W ramach podstaw teoretycznych omówiono koncepcje deficytu strukturalnego, pierwotnej równowagi fiskalnej oraz kryteria zrównoważoności długu publicznego. Część empiryczna opiera się na teście kointegracji Johansena i modelu korekty błędem (VECM), a uzupełniają ją wskaźniki stabilności fiskalnej Komisji Europejskiej (S1 ≈ 2,1 pp PKB; S2 ≈ 4,0–4,5 pp PKB) oraz analiza porównawcza z Czechami, Węgrami i Słowacją. Uzyskane wyniki potwierdzają trzy postawione hipotezy badawcze: strukturalne ujemne saldo pierwotne Polski jest trwałe w całym badanym okresie niezależnie od cyklu politycznego; między deficytem a długiem istnieje relacja kointegrująca, a szoki deficytowe przekładają się na trwały wzrost zadłużenia; ramy instytucjonalne — wobec braku wiążącej reguły salda strukturalnego i ograniczonych uprawnień rady fiskalnej — okazują się niewystarczające dla zapobiegania strukturalnym nierównowagom. Wykazano ponadto, że transfer aktywów OFE w 2014 roku obniżył mierzony poziom długu bez korekty salda strukturalnego. Polska zakwalifikowana została do kategorii średniego ryzyka fiskalnego. Jako warunek trwałej konsolidacji wskazano reformę instytucjonalną obejmującą wprowadzenie wiążącej reguły salda strukturalnego, średniookresowych ram budżetowych oraz wzmocnienie uprawnień Rady Fiskalnej w zakresie zatwierdzania prognoz makroekonomicznych.

Słowa kluczowe: deficyt budżetowy, dług publiczny, kointegracja, stabilność fiskalna, reguła fiskalna, Polska

Abstract

This thesis examines long-run dependencies between budget deficit and public debt in Poland over the period 1990–2023. The research objective is to establish the nature of these dependencies and to assess the institutional and structural factors conditioning fiscal sustainability. The theoretical framework draws on concepts of structural deficit, primary fiscal balance, and public debt sustainability criteria. The empirical analysis employs the Johansen cointegration test and vector error correction model (VECM), supplemented by European Commission fiscal sustainability indicators (S1 ≈ 2.1 pp of GDP; S2 ≈ 4.0–4.5 pp of GDP) and a comparative study covering the Czech Republic, Hungary, and Slovakia. The findings confirm all three research hypotheses: Poland's structural primary balance has been persistently negative throughout the analysed period, independently of political cycles; a cointegrating relationship between deficit and debt is confirmed, with deficit shocks transmitting to sustained debt increases; and the existing institutional framework — lacking a binding structural balance rule and featuring a fiscal council with limited authority — has proven insufficient to prevent structural fiscal imbalances. The analysis further demonstrates that the 2014 OFE asset transfer reduced measured debt without correcting the underlying structural balance. Poland is classified in the medium fiscal risk category according to European Commission indicators. Institutional reform — encompassing the introduction of a binding structural balance rule, a medium-term budgetary framework, and enhanced forecast endorsement authority for the Polish Fiscal Council — is identified as a precondition for durable fiscal consolidation.

Keywords: budget deficit, public debt, cointegration, fiscal sustainability, fiscal rule, Poland

List of Abbreviations

ADF

Augmented Dickey-Fuller

CEEC

Central and Eastern European Countries

CoA

Cost of Ageing (component of S2)

CUSUM

Cumulative Sum of Recursive Residuals

EC

European Commission

EDP

Excessive Deficit Procedure

ESA

European System of Accounts

EU

European Union

GDP

Gross Domestic Product

GFC

Global Financial Crisis

IBP

Initial Budget Position (component of S2)

MTBF

Medium-Term Budgetary Framework

MTO

Medium-Term Budgetary Objective

NBP

Narodowy Bank Polski (National Bank of Poland)

NDC

Notional Defined Contribution

NFZ

National Health Fund (Narodowy Fundusz Zdrowia)

OFE

Otwarte Fundusze Emerytalne (Open Pension Funds)

S1

European Commission Short-Term Fiscal Sustainability Indicator

S2

European Commission Long-Term Fiscal Sustainability Indicator

SGP

Stability and Growth Pact

VAT

Value Added Tax

VECM

Vector Error Correction Model

WPFP

Multi-Annual Financial Plan of the State (Wieloletni Plan Finansowy Państwa)

ZUS

Zakład Ubezpieczeń Społecznych (Social Insurance Institution)

Introduction

The relationship between budget deficits and the accumulation of public debt constitutes one of the central analytical problems in contemporary public finance and macroeconomic policy. The theoretical literature has long recognised that persistent fiscal imbalances, even when individually modest in magnitude, generate compounding long-run pressures on debt sustainability through the arithmetic of interest-growth differentials and the gradual erosion of fiscal space available to national governments. Yet the empirical dimension of this relationship — the precise channels through which deficit shocks transmit to debt dynamics, the role of institutional frameworks in moderating or amplifying this transmission, and the extent to which observed fiscal imbalances reflect structural rather than transitory pressures — remains insufficiently examined in the context of post-communist transition economies that have simultaneously undergone deep institutional transformation and integration into supranational fiscal governance frameworks. The case of the Republic of Poland offers an exceptionally well-defined laboratory for such an inquiry: over the period from 1990 to 2023, Poland experienced sustained and recurring budget deficits across periods of high economic growth, stagnation, and post-crisis consolidation alike, raising fundamental questions about whether the country's fiscal trajectory represents a cyclical phenomenon amenable to automatic stabilisation or a structural imbalance requiring deliberate institutional reform ^[8].

Poland's analytical significance for the study of deficit–debt dynamics extends across several dimensions that are rarely present in combination within a single national case. As a transition economy that completed a fundamental transformation of its public finance system during the 1990s — including the abolition of the monobank system, the introduction of a modern tax administration, and the controversial pension privatisation of 1999 — Poland provides a unique long-run time series in which the initial conditions of fiscal policy were themselves endogenous to a broader institutional design process. As an EU member state since 2004, Poland has operated under the Stability and Growth Pact's corrective framework and has been subject to the Excessive Deficit Procedure on multiple occasions, yet has nevertheless maintained structural deficits that have proven resistant to sustained consolidation. The country's constitutional debt ceiling, set at 60 per cent of GDP under Article 216 of the Polish Constitution and reinforced by a domestic public finance law establishing procedural limits at 55 and 60 per cent of GDP , has created a nominally stringent institutional constraint whose effectiveness in practice is substantially qualified by the political economy of fiscal adjustment and by the treatment of off-budget liabilities. Perhaps most consequentially for the long-run horizon, Poland faces one of the most severe demographic ageing trajectories among EU member states, with old-age dependency ratios projected to rise to levels exceeding 60 per cent by 2060, creating structural spending pressures in pension and healthcare systems that fundamentally condition any assessment of fiscal sustainability. These characteristics taken together elevate Poland from a merely illustrative national case to a theoretically and empirically important instance of the broader challenge of managing fiscal sustainability within the constraints of democratic institutions and supranational governance.

The central research objective of the present thesis is to establish and analyse the long-run dependencies between the budget deficit and the level of public debt in Poland over the period 1990–2023, and to assess the institutional and structural factors conditioning the sustainability of Poland's public finances in the medium and long term. This objective is pursued through a combination of quantitative and qualitative analytical methods: an examination of the dynamics of the general government deficit and debt series using Eurostat national accounts data compiled under the European System of Accounts 2010 methodology; an econometric investigation of the long-run equilibrium relationship between these series using cointegration analysis and a vector error correction model; a comparative assessment of Poland's structural deficit performance relative to three regional peers — the Czech Republic, Hungary, and Slovakia — that share broadly similar institutional and historical conditions; and an application of the European Commission's fiscal sustainability indicators S1 and S2 to assess the magnitude of the adjustment required to stabilise Poland's debt ratio and satisfy long-run solvency constraints. The thesis is thus located at the intersection of empirical public finance, institutional economics, and fiscal policy analysis, and draws on theoretical frameworks drawn from the political economy of budget deficits ^[15], the debt dynamics literature, and the analysis of fiscal rules and independent fiscal institutions ^[9].

Three specific research hypotheses guide the empirical and analytical work of the thesis. The first hypothesis posits that budget deficits in Poland exhibit a structural character that is not fully explained by cyclical factors, and that the structural primary balance has been persistently negative over the period 2000–2023. This hypothesis is motivated by the observation that Poland recorded a general government deficit in nearly every fiscal year across the study period, including years of robust positive output gaps, suggesting that the observed fiscal imbalances cannot be accounted for solely by the operation of automatic stabilisers and discretionary countercyclical policy. The second hypothesis asserts that a long-run cointegrating relationship exists between the budget deficit and the level of public debt in Poland, such that deficit shocks transmit to persistent increases in the debt-to-GDP ratio without the full and automatic correction implied by Ricardian equivalence or by the self-stabilising properties of an intertemporally solvent fiscal policy. The confirmation of this hypothesis through a vector error correction model would imply that deficit and debt in Poland are bound by a common stochastic trend, and that fiscal adjustment episodes have not been sufficiently sustained to break this long-run dependency. The third hypothesis contends that the institutional framework governing fiscal policy in Poland — characterised by the absence of a binding structural balance rule, the limited operational independence of the Fiscal Council, and weaknesses in medium-term budgetary planning — has been insufficient to prevent the accumulation of structural fiscal imbalances, and that the comparative experience of Poland's regional peers reinforces this conclusion. Together, these hypotheses frame the thesis as an examination not merely of fiscal outcomes but of the institutional conditions that generate and perpetuate those outcomes.

The temporal scope of the analysis encompasses the period from 1990 to 2023, a span of thirty-three years that captures the full arc of Poland's fiscal transformation from a centrally planned economy to a market economy operating within a supranational fiscal governance framework. The starting point of 1990 is selected for its analytical significance as the year of the Balcerowicz stabilisation programme, which established the macroeconomic and institutional foundations of the contemporary Polish public finance system and from which continuous comparable fiscal data begin to be available. The endpoint of 2023 represents the most recent full fiscal year for which general government accounts under the ESA 2010 methodology are available in Eurostat's databases, enabling a temporally complete and methodologically consistent dataset. The geographic scope of the primary analysis is national, focused on the Republic of Poland, with a comparative dimension introduced in the third chapter through parallel analysis of the Czech Republic, Hungary, and Slovakia — three Visegrad group members that share Poland's post-communist institutional heritage and exposure to EU fiscal governance frameworks while exhibiting divergent trajectories of structural deficit management. The primary data sources are Eurostat's Government Finance Statistics and the AMECO macroeconomic database, supplemented by data from the Polish Ministry of Finance and the European Commission's periodic fiscal sustainability assessments. All deficit and debt data are reported on a general government consolidated basis, consistent with ESA 2010 accounting standards ^[1].

The methodological framework employed in the thesis draws on three distinct but complementary analytical traditions. The descriptive and analytical review of Poland's fiscal policy history draws on both quantitative data and the qualitative analysis of legislative and policy documents, situating the observed fiscal outcomes within the context of specific political economy episodes — the pension reform of 1999, the post-2008 fiscal stimulus, the 2014 transfer of Open Pension Fund assets to ZUS — that produced measurable discontinuities in the deficit and debt series and whose interpretation requires contextual institutional knowledge ^[7]. The econometric analysis employs the Johansen cointegration test and a vector error correction model to examine whether the deficit and debt series are bound by a long-run equilibrium relationship, following the methodological approach established in the fiscal sustainability literature for small open economies and transition economies in Central and Eastern Europe ^[4], ^[11]. This approach enables the estimation of the speed of adjustment to long-run equilibrium following deficit shocks, the identification of the direction of Granger causality between the two series, and the testing of the fiscal sustainability hypothesis in its weak and strong forms. Finally, the sustainability assessment framework draws on the European Commission's S1 and S2 indicators, which measure the fiscal adjustment required to meet the 60 per cent of GDP debt benchmark by 2030 and to satisfy long-run intertemporal solvency, respectively, and incorporates the Commission's assessment of implicit liabilities arising from ageing-related spending commitments. This triangulation of methodological approaches reflects the conviction that the relationship between deficits and public debt in Poland cannot be adequately characterised through any single analytical lens.

The thesis is structured across three chapters, each addressing a distinct dimension of the overall research objective. The first chapter establishes the theoretical and conceptual foundations of the analysis. It opens with a precise definition of the constituent elements of the general government budget balance — revenues, expenditures, and the resulting surplus or deficit — and introduces the distinction between cyclical and structural components of the deficit that is central to the empirical hypotheses of the thesis. The chapter proceeds to examine the measurement of public debt under the ESA 2010 methodology, the arithmetic of debt dynamics as mediated by the interest-growth differential and the primary balance, and the principal theoretical frameworks through which economists have analysed the macroeconomic consequences of deficit financing: the Ricardian equivalence proposition, the crowding-out of private investment, and the political economy models of fiscal inertia. The chapter closes with an analysis of fiscal rules and independent fiscal institutions as instruments of fiscal commitment, examining the typology of rules — structural balance, nominal, debt level, and expenditure growth rules — and the empirical evidence on their effectiveness in reducing structural deficits and containing the accumulation of public debt. The second chapter provides the empirical core of the thesis. It reconstructs Poland's fiscal policy trajectory over the period 1990–2023 in five analytically distinct phases — the transition crisis and initial stabilisation of 1990–1993, the reform-driven consolidation of 1994–1999, the post-reform structural expansion of 2000–2007, the global financial crisis and its fiscal aftermath from 2008–2015, and the post-consolidation period of 2016–2023 — and analyses the structural and cyclical determinants of deficit persistence within each phase. The chapter presents the results of the cointegration and VECM analysis establishing the long-run equilibrium relationship between deficit and debt, examines the methodological implications of the 2014 OFE asset transfer for the interpretation of the debt series, and situates Poland's structural deficit performance within a comparative framework encompassing its three regional peers. The third chapter translates the empirical findings into a forward-looking policy assessment. It presents the results of the S1 and S2 sustainability indicator calculations, quantifies the implicit liabilities arising from demographic ageing and pension system dynamics, evaluates the track record of Poland's past fiscal consolidation efforts, and formulates a set of institutional reform recommendations — the introduction of a structural balance rule, the strengthening of the medium-term budgetary framework, the reform of tax expenditure governance, and the enhancement of the operational independence of the Polish Fiscal Council — whose adoption is identified as a precondition for credible and durable fiscal adjustment. The thesis concludes with a synthesis of the main empirical findings, a reflection on the broader implications of the Polish case for the design of fiscal institutions in transition economies, and an assessment of the limitations of the present analysis and the directions for future research.

Chapter 1. Theoretical Foundations of Budget Deficit and Public Debt

1.1. Conceptual Framework of Public Finance

The study of budget deficits and public debt necessarily begins with the terminological foundations upon which quantitative analysis and policy prescription are built. Public finance, as a field of inquiry, is concerned with the revenues collected by the state, the expenditures it incurs, and the balance — or imbalance — that arises between these two flows over a defined accounting period. The clarity of these definitions is not merely a technical matter; it shapes what is measured, what is reported, and ultimately what is subject to legal constraint and democratic oversight. As has been observed in the literature, the transparency of public finances depends in no small part upon methodological consistency in the classification and measurement of fiscal aggregates ^{[1, s. 192]}.

Public revenues are conventionally divided into two broad categories: tax revenues and non-tax revenues. Tax revenues encompass compulsory levies imposed upon individuals, households, and enterprises by virtue of public authority, including income taxes, corporate taxes, value-added taxes, excise duties, and social security contributions. Non-tax revenues include fees for public services, dividends from state-owned enterprises, revenues from the sale of public assets, fines and penalties, and income from public property. The distinction between these categories carries both economic significance — inasmuch as the distortionary effects of taxation differ from those of non-tax instruments — and legal significance, since constitutional and statutory provisions frequently treat them separately.

Public expenditures, the counterpart to revenues, are classified along several dimensions. The current versus capital distinction is of particular analytical importance. Current expenditures comprise those outlays that are consumed within the budget year and do not give rise to the formation of durable assets; they include wages and salaries of public employees, purchases of goods and services, transfer payments such as social benefits and pensions, and interest payments on existing debt. Capital expenditures, by contrast, involve the acquisition or construction of fixed assets — infrastructure, equipment, buildings — and contribute to the expansion of the productive capacity of the public sector. This distinction matters for the assessment of fiscal policy because capital expenditure, though it may widen the deficit in the short term, may generate returns that contribute to future revenue capacity and economic growth.

The budgetary balance is defined as the difference between total public revenues and total public expenditures within a given fiscal year. A positive balance — a surplus — indicates that revenues exceed expenditures; a negative balance — a deficit — indicates the converse. The nominal or headline budget deficit is the most commonly reported measure and is calculated on the basis of actual cash flows or accruals, depending on the accounting convention employed. The legal limits applicable to public expenditure represent, as the literature notes, boundaries upon the political freedom of public authorities in the creation and implementation of fiscal policy ^{[1, s. 177]}. These limits do not eliminate the deficit as a policy instrument, but they circumscribe the conditions under which deficit financing may be pursued.

A further distinction of fundamental analytical importance is that between the cyclical and structural components of the budget balance. The cyclical deficit arises automatically as a consequence of the business cycle: during economic downturns, tax revenues fall and expenditures on unemployment benefits and other automatic stabilisers increase, even in the absence of any discretionary policy change. The structural — or cyclically adjusted — deficit, by contrast, represents that portion of the deficit that persists even when output is at its potential level. It reflects deliberate policy choices regarding the level of taxation and public spending and is therefore the appropriate measure when assessing the underlying fiscal stance of a government. The decomposition of the observed balance into these components requires an estimate of potential output and the output gap, which introduces a degree of uncertainty into fiscal analysis.

The measurement of fiscal aggregates at the supranational level is governed by the European System of Accounts 2010 (ESA 2010), which establishes a harmonised framework for the compilation of national accounts and fiscal statistics across the member states of the European Union. Under ESA 2010, the general government sector encompasses four subsectors: central government, state government, local government, and social security funds. The coverage of this sector definition is critical because it determines which entities and financial flows are included in the calculation of the deficit and debt reported to the European Commission under the Excessive Deficit Procedure. Discrepancies between national accounting frameworks and ESA 2010 classifications have been a recurring source of methodological complexity, particularly in the Polish context, where the perimeter of the public finance sector has been subject to periodic revision ^{[1, s. 192]}.

1.2. The Nature and Classification of Public Debt

Public debt may be understood, in its most fundamental sense, as the accumulation of past budgetary imbalances that have been financed through borrowing. When a government incurs a deficit in a given fiscal year, it must obtain the necessary resources from creditors — domestic or foreign, public or private — and thereby creates a corresponding liability. The stock of such liabilities, net of any accumulated financial assets, constitutes the public debt. The precise delineation of what is to be included in this stock, and how it is to be valued and reported, is a matter of considerable methodological and policy significance.

The most fundamental taxonomy distinguishes between gross and net debt. Gross debt encompasses all outstanding liabilities of the general government sector, irrespective of the financial assets held on the other side of the public sector's balance sheet. Net debt, by contrast, deducts financial assets — including cash balances, deposits, and holdings of financial instruments — from the gross liability figure, thereby providing a measure of the government's net financial position. The Maastricht criterion, which forms the basis of fiscal surveillance under the European Union's Stability and Growth Pact, employs a measure of gross consolidated debt, defined as the nominal value of all gross liabilities of the general government sector at the end of the year, with intra-sector claims eliminated through consolidation.

Table 1.1. Principal Classifications of Public Debt

Classification Criterion	Category A	Category B	Analytical Relevance
Measurement basis	Gross debt	Net debt	Net debt accounts for financial assets; gross debt is standard for EU surveillance
Creditor residence	Domestic debt	External debt	External debt exposure to exchange rate risk and capital flow reversals
Maturity	Short-term (<1 year)	Long-term (>1 year)	Short-term debt raises rollover risk; long-term debt locks in interest costs
Explicitness of obligation	Explicit liabilities	Contingent liabilities	Contingent liabilities may crystallise under adverse economic conditions
Currency denomination	Domestic currency	Foreign currency	Foreign currency debt creates vulnerability to exchange rate depreciation

A second major classification axis concerns the residence of creditors. Domestic debt is owed to residents of the issuing country — households, financial institutions, pension funds, and other domestic investors — while external debt is owed to non-residents. This distinction is economically important for several reasons. Interest payments on domestic debt represent a transfer within the national economy, affecting the distribution of income between debtors (taxpayers) and creditors (domestic bondholders) without a direct aggregate demand effect. Payments on external debt, by contrast, constitute a resource transfer abroad and may therefore affect the current account balance and the exchange rate. Countries with a high share of external debt are additionally exposed to the risk that shifts in investor sentiment, changes in global risk appetite, or deterioration in sovereign credit ratings may lead to sudden capital outflows and financing difficulties.

The maturity dimension of the debt portfolio — the distinction between short-term instruments (with original maturities of one year or less) and long-term instruments — is relevant to the management of rollover risk. A government that has financed a substantial portion of its debt through short-term instruments must continually return to the market to refinance maturing obligations. Should market conditions deteriorate — whether due to a deterioration in fiscal fundamentals, a generalised tightening of credit conditions, or a loss of investor confidence — the cost of rollover may increase sharply, or access to financing may be curtailed altogether. The composition of the debt portfolio in terms of maturity is therefore a key parameter in public debt management strategy.

The distinction between explicit and contingent liabilities represents a further dimension of the debt taxonomy that has gained increasing prominence in the context of financial sector crises and demographic pressures. Explicit liabilities are legally binding obligations whose existence and magnitude are known with certainty — government bonds and loans are the paradigmatic case. Contingent liabilities, by contrast, are obligations that materialise only upon the occurrence of specific events; they include government guarantees extended to the banking sector or state-owned enterprises, implicit guarantees to systemically important financial institutions, unfunded pension obligations arising from pay-as-you-go systems, and potential liabilities arising from public-private partnership arrangements. The methodological challenge posed by contingent liabilities is that conventional fiscal accounting frameworks, including ESA 2010, record them only when they crystallise, so that the fiscal risk they represent may be systematically understated in headline debt figures.

EU definitional standards — particularly those embedded in ESA 2010 and applied through the Maastricht Protocol — have been a source of methodological complexity in the Polish context. The existing methodological dualism in defining and determining the structure of public debt in accordance with Polish solutions and EU requirements does not contribute to maintaining the transparency of public finances and makes it difficult to compare data, while at the same time enabling creative financial policy on the part of the state ^{[1, s. 192]}. Legislative amendments extending the subjective scope of the public finance sector have contributed to reducing differences in the EU and Polish methodology regarding the general government sector and thus in the calculation of the public deficit and debt ^{[1, s. 192]}. These methodological tensions are not merely technical; they have substantive implications for the measured level of the deficit and debt ratios that serve as the basis for fiscal surveillance and the application of corrective mechanisms.

Constitutional limits on debt exist in several EU member states and have been subject to renewed scrutiny in the context of the extraordinary fiscal pressures generated by the COVID-19 pandemic, which prompted reconsideration of whether these limits require adjustment in light of the economic conditions prevailing at the time . The experience of the pandemic illustrated that the design of debt limits — in particular, whether they incorporate escape clauses for exceptional circumstances — has significant implications for the capacity of governments to respond to major macroeconomic shocks.

1.3. Theoretical Mechanisms Linking Fiscal Deficits to Debt Accumulation

The relationship between the annual fiscal deficit and the stock of public debt is governed by the government budget constraint, which constitutes the fundamental accounting identity of public sector finance. In its most elementary form, the budget constraint states that the change in the stock of debt between two periods is equal to the primary deficit — defined as the deficit before interest payments — plus interest payments on the outstanding stock of debt. This identity implies that even a government running a primary surplus may experience an increase in its debt ratio if interest payments on existing debt exceed the surplus generated. Conversely, a government running a primary deficit will see its debt increase by more than the deficit alone, as interest compounds on the outstanding stock.

The debt dynamics equation, derived from the government budget constraint, expresses the change in the debt-to-GDP ratio as a function of the primary deficit ratio, the real interest rate on debt, and the real GDP growth rate. This formulation reveals the so-called snowball effect: when the real interest rate exceeds the real growth rate, the debt ratio tends to rise even in the absence of new primary deficits, as the real cost of servicing existing debt outpaces the expansion of the tax base. Conversely, when growth exceeds the interest rate, the debt ratio can decline even in the presence of moderate primary deficits. The condition under which the debt ratio is stabilised — and thus the condition for debt sustainability — is that the primary balance is at least equal to the product of the existing debt ratio and the differential between the interest rate and the growth rate.

The Domar model of debt dynamics, developed in the mid-twentieth century, provides a foundational analytical framework for understanding this relationship. The model demonstrates that a constant primary deficit as a share of GDP will, under conditions of positive economic growth, eventually stabilise the debt ratio at a finite level determined by the ratio of the deficit to the growth rate. The intuition is that continuous economic growth expands the denominator — GDP — relative to the numerator — the debt stock — so that even a permanently borrowing government does not necessarily face an explosive debt path, provided growth is sufficiently robust. However, the model also shows that a higher deficit-to-GDP ratio implies a higher long-run debt-to-GDP ratio, and that adverse shocks to growth or increases in borrowing costs can shift an otherwise stable debt path onto an explosive trajectory.

The relevance of these dynamics was clearly illustrated in the euro area context during the period of low economic growth that followed the global financial crisis. The author of one study analysed whether expansionary fiscal policy would contribute to the growth of real output, or merely enlarge the public debt and increase the risk of sovereign debt default and currency crisis ^[2]. The analysis concluded that expansionary fiscal policy generating budget deficit growth and enlargement of public debt as a ratio to GDP is likely to result from the structural nature of fiscal intervention, which fails to stimulate the economy under conditions of insufficient demand ^{[2, s. 213]}. This finding underscores the importance of the growth rate component in debt dynamics: if fiscal expansion fails to raise GDP growth sufficiently to offset the increase in debt, the deficit-financing strategy may set in motion a self-reinforcing deterioration in the debt ratio.

Stock-flow adjustments represent an additional channel through which the public debt stock may change in ways not captured by the measured deficit. These adjustments include the accumulation of financial assets (which raises the debt stock without affecting the deficit under accrual accounting), the assumption of contingent liabilities that have crystallised, valuation changes in foreign currency-denominated debt, and statistical reclassifications of entities into or out of the general government sector. In the Polish context, such adjustments have been of practical significance, as legislative changes affecting the perimeter of the public finance sector have altered the measured level of the debt ratio without any corresponding change in the underlying fiscal position. The transparency implications of such adjustments are significant: if the reported deficit understates the true increase in the debt stock, fiscal surveillance mechanisms may be triggered too late to prevent the accumulation of an unsustainable fiscal position.

The interaction between monetary policy and debt dynamics constitutes a further dimension of the theoretical framework. During the COVID-19 pandemic, the National Bank of Poland adopted an ultra-expansionary monetary policy, which included lowering interest rates and purchasing securities as part of structural open market operations . The lowering of interest rates directly reduces the real cost of debt service, thereby alleviating the snowball effect and improving debt sustainability arithmetic in the short term. However, such a policy may also generate negative consequences, the most important of which proved to be the emergence of high inflation with all its economic and social costs ^[3]. Elevated inflation erodes the real value of nominally fixed debt — a form of financial repression — but also distorts relative prices, reduces the real incomes of households, and may ultimately necessitate a sharp tightening of monetary policy that raises interest rates and thereby reverses the initial improvement in debt dynamics.

1.4. Crowding-Out Effects and Macroeconomic Consequences of Debt Growth

The macroeconomic consequences of deficit financing and public debt accumulation have been extensively debated in the theoretical literature, with disagreement persisting over both the sign and the magnitude of the relevant effects. The classical crowding-out hypothesis, rooted in the loanable funds framework, holds that increased government borrowing raises the equilibrium real interest rate in the market for loanable funds, thereby reducing private investment. The mechanism operates as follows: the government enters the market for savings as a borrower, increasing demand for funds without a corresponding increase in supply, thereby driving up the price of funds — the real interest rate. As the cost of borrowing rises, private investment projects that were previously profitable become unprofitable at the margin, and the aggregate volume of private capital formation declines. To the extent that private capital formation is a key determinant of long-run productive capacity, crowding out of investment implies a reduction in the economy's long-run growth potential.

The severity of crowding-out depends upon several parameters, including the interest elasticity of private investment, the openness of the economy to capital flows, and the degree of excess capacity in the economy. In a closed economy at full employment, government borrowing may crowd out private investment on a near one-for-one basis. In an open economy with mobile capital, the increase in domestic interest rates may attract foreign capital inflows, appreciating the exchange rate and crowding out net exports rather than domestic investment. In an economy operating below potential, with idle resources and low investment demand, the crowding-out effect may be substantially attenuated, as the demand-side stimulus of government spending activates previously underutilised resources.

The Ricardian equivalence theorem, associated with the work of Robert Barro, represents the most radical challenge to the view that deficit financing has real macroeconomic consequences. Under the conditions specified by the theorem, rational, forward-looking households recognise that a current tax cut financed by government borrowing implies higher future taxes whose present discounted value is equal to the current reduction in taxation. Households therefore increase their saving by the full amount of the tax reduction, in anticipation of future tax liabilities, leaving national saving and hence private investment unchanged. The fiscal multiplier is zero, and the method of financing public expenditure — taxation versus borrowing — is entirely irrelevant to real economic outcomes.

• Ricardian equivalence requires perfect capital markets in which households can borrow and lend at the same rate as the government — a condition that does not hold when liquidity constraints bind on a significant fraction of the population.
• The theorem assumes an infinite planning horizon or, equivalently, that households have altruistic bequest motives linking them to future generations — an assumption that may not hold universally.
• It requires that households have full information about the government's intertemporal budget constraint and form rational expectations about future tax policy — conditions that impose substantial cognitive demands.
• The theorem abstracts from distortionary taxation: if current deficit financing is repaid through distortionary future taxes rather than lump-sum taxes, the equivalence breaks down even within the model's own framework.^{[18, s. 36]}

The empirical evidence on Ricardian equivalence is mixed, with most studies finding that it holds only partially, if at all. Liquidity-constrained households — those unable to borrow against future income — respond to tax cuts by increasing consumption rather than saving, generating positive fiscal multiplier effects that are inconsistent with full Ricardian equivalence. The practical implication is that the method of financing public expenditure does have real consequences, even if those consequences are smaller than the simple Keynesian multiplier framework would suggest.

The relationship between public debt and economic growth has been studied empirically through cross-country panel analyses, with a body of evidence pointing to a non-linear, threshold effect. At moderate levels of indebtedness, the relationship between debt and growth may be positive or neutral, as borrowing finances productive public investment. However, beyond a certain debt threshold — frequently cited in the literature as falling in the range of 80 to 90 percent of GDP, though with substantial uncertainty around this estimate — the relationship appears to turn negative. Several transmission mechanisms have been advanced to account for this non-linearity.

• At high debt levels, the government's need to service debt crowds out productive public expenditures, including investment in infrastructure, education, and research and development, reducing the long-run growth potential of the public sector.
• Elevated debt ratios are associated with higher risk premia on sovereign bonds, raising the cost of borrowing for both the public sector and private firms whose creditworthiness is linked to sovereign credit quality.
• High indebtedness may generate uncertainty about future fiscal policy — in particular, about the risk of eventual monetisation, debt restructuring, or sharp fiscal consolidation — that depresses private investment through a confidence channel.
• The intergenerational dimension of debt accumulation implies that current borrowing transfers resources from future taxpayers to current generations, raising questions of intergenerational equity that are analysed within overlapping generations models.

The distinction between demand-side and supply-side effects of fiscal policy is critical in this context. Demand-side action through expansionary fiscal policy may generate short-term output gains, but these are not built on a stable macroeconomic foundation; they may be accompanied by inflation, budget deficit growth, and depreciation of the national currency, which become barriers to growth in the long run ^{[2, s. 204]}. Supply-side action, by contrast, which improves the conditions for investment and production, constitutes a source of long-run economic growth because it increases the productive capacity of the economy ^[2]. New investment projects arise, primary production increases, the incomes of factors of production rise, aggregate demand expands, and secondary increases in output are generated through the multiplier process ^[2].

The ultra-expansionary monetary policy pursued during the pandemic illustrated the distributive consequences of debt-financed fiscal expansion. The consequence of such policy — the Cantillon effect — implies a differentiated impact of new money creation on sectors of the economy and social groups, contributing to a division of society into winners and losers of monetary and fiscal changes, mainly at the expense of consumers ^{[3, s. 52]}. Holders of real assets and financial instruments benefited from asset price inflation, while households dependent on wages and transfer payments experienced an erosion of purchasing power through consumer price inflation. These distributive consequences are not captured by aggregate debt sustainability metrics but are of considerable importance for the political economy of fiscal consolidation.

Rollover risk, interest rate risk, and currency risk constitute the principal financial risks associated with a large public debt stock. Rollover risk arises when a significant volume of maturing debt must be refinanced within a short period; if market conditions are adverse at the time of refinancing, the government may face prohibitively high borrowing costs or an outright inability to access market financing. Interest rate risk arises when a substantial portion of the debt carries variable interest rates, so that an increase in the general level of interest rates translates directly into higher debt service costs. Currency risk materialises when a portion of the debt is denominated in foreign currencies; exchange rate depreciation raises the domestic currency value of both the principal and interest obligations on foreign currency debt, worsening the debt sustainability position precisely when the economy may already be under stress.

1.5. Fiscal Rules and Institutional Constraints on Deficit Financing

The tendency of democratic governments to generate persistent deficits — even in the absence of exceptional circumstances that might justify borrowing — has been explained in the theoretical literature through several complementary analytical frameworks. The common pool problem arises because the benefits of public expenditure accrue primarily to specific constituencies, while the tax burden required to finance it is spread across the entire population of taxpayers. Each interest group therefore has an incentive to lobby for spending that benefits its members while bearing only a fraction of the corresponding fiscal cost, generating an aggregate level of public expenditure and borrowing that exceeds the socially optimal level. The problem is most acute when government is characterised by fragmented decision-making, as in coalition governments or legislatures with strong committee structures, because the coordination failure inherent in the common pool is deepest in these settings.

Political business cycle theory provides a complementary explanation: incumbent governments have an incentive to expand fiscal deficits prior to elections in order to generate short-term economic stimulus and thereby enhance their electoral prospects, while passing the costs of eventual adjustment to their successors or to future governments. The time inconsistency of optimal fiscal policy — whereby commitments made at one point in time become suboptimal once circumstances change — creates a structural bias toward deficit financing that is not eliminated by democratic accountability alone. Fiscal rules and independent fiscal institutions are the institutional response to these deficit biases; their purpose is to precommit governments to prudent fiscal behaviour by subjecting budgetary decisions to constraints that are costly to violate.

The Polish constitutional framework embeds a direct limit on public debt in Article 216 of the Constitution of the Republic of Poland, which prohibits the contracting of loans or the granting of guarantees and sureties that would cause the state public debt to exceed three-fifths — 60 percent — of the value of annual gross domestic product. This constitutional ceiling represents the uppermost limit of a graduated system of institutional safeguards established in the Public Finance Act. The Act specifies two intermediate thresholds: when the national public debt ratio reaches 50 percent of GDP, requirements for deficit reduction in the following year's budget come into force; at 55 percent, more stringent corrective measures are activated, including restrictions on the indexation of public sector wages and social benefits and prohibitions on the creation of new discretionary spending programmes; at 60 percent, the constitutional limit triggers an obligation to present a balanced budget for the following year.

Table 1.2. Fiscal Thresholds and Corrective Mechanisms in Poland

Threshold	Legal Basis	Principal Corrective Obligations	Nature of Constraint
50% of GDP	Public Finance Act	Deficit in subsequent budget ≤ deficit in current budget (% GDP); restrictions on new guarantees	Preventive — triggers when approached
55% of GDP	Public Finance Act	Prohibition on wage/benefit indexation; no new discretionary expenditure; compulsory expenditure reduction programme	Corrective — statutory obligation to consolidate
60% of GDP	Art. 216 of the Constitution	Obligation to present balanced budget for the following year; prohibition on further borrowing above ceiling	Constitutional — supreme legal norm, cannot be overridden by ordinary legislation
Medium-Term Objective	Stability and Growth Pact (preventive arm)	Annual structural adjustment of at least 0.5% of GDP if MTO not achieved; more rapid adjustment when cyclical conditions allow	EU — enforced through European Semester; sanctions possible
3% of GDP (deficit); 60% (debt)	Maastricht Treaty / Stability and Growth Pact (corrective arm)	Excessive Deficit Procedure: recommendations, financial deposits, and fines for euro area member states; reputational costs for non-euro members	EU — treaty obligation; legally binding recommendations

The Stability and Growth Pact (SGP) provides the supranational dimension of fiscal surveillance for European Union member states. The Pact operates through two arms: the preventive arm and the corrective arm. The preventive arm requires each member state to pursue a country-specific Medium-Term Budgetary Objective (MTO) expressed in terms of the structural balance — the cyclically adjusted balance net of one-off and temporary measures. The MTO is designed to provide a sufficient safety margin below the reference value of a deficit of 3 percent of GDP to allow automatic stabilisers to operate freely over the business cycle without the risk of breaching the reference value. Countries that have not yet achieved their MTO are expected to make annual structural adjustments of at least 0.5 percent of GDP toward it, with more rapid adjustment required in good economic times. The corrective arm of the Pact — the Excessive Deficit Procedure (EDP) — is activated when a member state's deficit exceeds 3 percent of GDP or its debt ratio exceeds 60 percent of GDP and is not declining at a sufficiently rapid pace. The analysis of the EDP points to differences between countries in their approach to debt regulation and the challenges associated with maintaining the balance of public finances in the face of changing economic conditions ^{[1, s. 210]}.

Poland, as a non-euro area member state, is subject to the provisions of the SGP under a slightly less stringent enforcement regime than euro area members: financial sanctions available under the SGP are not directly applicable, though reputational costs, restrictions on access to EU Cohesion Fund resources, and the obligation to submit adjustment programmes all constitute significant incentives for compliance. The legal limits of public expenditure represent direct spending boundaries and also include the obligation of dialogue, fiscal rules, expenditure procedures, and budgetary control, all of which constrain the political freedom of public authorities in the formulation of fiscal policy ^{[1, s. 177]}.

Poland's stabilising expenditure rule, introduced in 2015 through amendments to the Public Finance Act, represents a more technically sophisticated fiscal instrument than the simple debt thresholds described above. The rule limits the growth of discretionary public expenditure — broadly defined to include most categories of central government spending, as well as contributions to local governments and certain transfers — to a reference rate derived from the medium-term nominal GDP growth rate, adjusted for the cyclical position of the economy and the distance of the actual balance from the target. The expenditure rule operates as the primary operational constraint on year-to-year budgetary decisions, complementing the stock-based debt thresholds with a flow-based mechanism that prevents the accumulation of structural deficits even during periods when the headline debt ratio remains below the reference values.

The comparative assessment of fiscal rule design reveals several dimensions along which rules may differ in their effectiveness. Rules expressed in terms of the structural balance are theoretically superior to nominal balance rules in that they allow automatic stabilisers to operate without triggering corrective mechanisms during cyclical downturns. However, they depend upon the estimation of unobservable quantities — potential output and the output gap — which introduces measurement uncertainty and creates scope for creative reinterpretation. Expenditure rules avoid this problem by anchoring to an observable quantity, but they require careful specification of what expenditures are covered and what adjustments are permitted. Rules that incorporate escape clauses for exceptional circumstances provide desirable flexibility but may be invoked opportunistically if the conditions for activation are not tightly defined. The pandemic conditions prompted reconsideration of whether constitutional debt limits require adjustment in light of extraordinary economic circumstances ^{[1, s. 210]}, illustrating the tension between the commitment value of rigid rules and the need for flexibility in genuine emergencies.

• Structural balance rules provide countercyclical flexibility but rely on unobservable potential output estimates that are subject to ex post revision and potential manipulation.
• Nominal balance rules are transparent and easily verifiable but may force procyclical fiscal tightening during recessions, amplifying output volatility.
• Debt level rules anchor the long-run sustainability of the fiscal position but provide little guidance on the permissible pace of debt reduction and may leave the annual fiscal stance indeterminate.
• Expenditure growth rules are operationally straightforward and avoid the output gap estimation problem, but they require careful design of coverage and adjustment mechanisms to prevent circumvention through reclassification of expenditure categories.

The effectiveness of fiscal rules depends not only upon their technical design but also upon the institutional framework within which they are embedded. Independent fiscal institutions — variously termed fiscal councils, parliamentary budget offices, or fiscal watchdogs — have been established in a growing number of countries, including Poland, to provide independent assessments of macroeconomic and fiscal forecasts, monitor compliance with fiscal rules, and alert the public to emerging fiscal risks. The existence of such institutions enhances the credibility of fiscal commitments by reducing the informational asymmetry between the government and the public regarding the true state of the public finances. Budgetary control mechanisms, as part of the broader framework of fiscal governance, constitute one of the legal limits on public expenditure identified in the literature ^{[1, s. 177]}, and their effectiveness conditions the degree to which formal fiscal rules translate into actual fiscal discipline.

The interaction between fiscal rules and monetary policy frameworks constitutes a further dimension of the institutional landscape. A government constrained by a fiscal rule and unable to finance extraordinary expenditures through borrowing may turn to the central bank as a lender of last resort, eroding the independence of monetary policy and ultimately generating inflationary pressure. The experience of the COVID-19 pandemic provided a test of these interactions: the ultra-expansionary policies of central banks, including the National Bank of Poland, were accommodated by and accommodating to substantial fiscal expansion, with the consequences — including a significant rise in inflation — becoming apparent with a lag . The design of fiscal rules must therefore account for the monetary policy environment, and vice versa, to ensure that institutional constraints on deficit financing are not circumvented through quasi-fiscal operations of the central bank or through creative accounting devices that exploit definitional gaps in the applicable rules.

Chapter 2. Empirical Analysis of Budget Deficit and Public Debt in Poland, 1990–2023

2.1. Poland's Fiscal Policy Transformation after 1989

The fiscal architecture inherited by the Polish state in 1989 bore the structural imprint of four decades of centrally planned economic management. Under the socialist model, the national budget functioned not as an independent instrument of macroeconomic governance but as an accounting appendix to the central plan: revenues were derived predominantly from transfers from state-owned enterprises, whose profits were appropriated by the state, while expenditures were administered through branch ministries according to plan targets rather than market signals. The concept of a fiscal deficit in the Western sense was largely absent from official discourse, since the state could compel enterprise transfers and control prices administratively. Monetary financing of imbalances — through the National Bank of Poland, which simultaneously fulfilled central bank and commercial bank functions — was the default mechanism for covering any shortfall. The separation of monetary and fiscal functions, a foundational precondition for sound public finance management, had yet to be established within the Polish institutional environment.

The onset of the Balcerowicz stabilisation programme in January 1990 precipitated an immediate and profound fiscal shock. The simultaneous liberalisation of administered prices, removal of enterprise subsidies, introduction of internal convertibility of the zloty, and tightening of credit conditions caused the Polish economy to contract by approximately 11.6 per cent in 1990 and a further 7.0 per cent in 1991. The fiscal consequences were severe and manifested through two simultaneous channels. On the revenue side, enterprise profit tax receipts collapsed as state firms lost their monopolistic pricing privileges and were exposed to import competition following trade liberalisation. On the expenditure side, social spending commitments expanded sharply as unemployment — effectively unknown under the socialist system — emerged on a large scale, necessitating the rapid construction of an unemployment benefit system and the extension of early retirement and disability provisions as instruments for managing the labour market consequences of enterprise restructuring. In comparative studies of post-transition economies, it has been noted that both Poland and peer countries in the region experienced significant public finance deficits financed in part through monetary emission during this period, with Poland recording an inflation rate of 685.8 per cent in 1990 .

The construction of a market-consistent public finance system proceeded through several legislative and institutional milestones across the first post-transition decade. The introduction of personal income tax in 1992 and the replacement of the turnover tax with value-added tax in 1993 established broad-based taxation as the principal revenue instrument, gradually reducing dependence on enterprise profit transfers and creating a more buoyant and automatic revenue base aligned with the business cycle. The Social Insurance Institution (Zakład Ubezpieczeń Społecznych, ZUS) was reorganised as a quasi-autonomous entity responsible for administering the pay-as-you-go pension, disability, and sickness insurance systems, though its fiscal relationship with the central budget remained close throughout the 1990s: recurrent transfers were required to cover actuarial shortfalls as the dependency ratio deteriorated relative to the assumptions embedded in the system's contribution rates. The institution of the social insurance framework in its reformed post-transition form created a structural tendency toward deficit in the social funds sub-sector that was to persist into the subsequent decade.

Local government finance was progressively separated from central budget administration through a sequence of reforms. The communal self-government reform of 1990 restored the institution of the gmina and assigned it specific revenue streams and service responsibilities formerly discharged by deconcentrated central administration. The comprehensive territorial and administrative decentralisation of 1998–1999 extended this framework to the powiat and województwo tiers, establishing a three-tier local government system with constitutionally guaranteed access to shared national taxes and independent borrowing authority subject to statutory debt limits. These reforms had the effect of moving a significant share of public expenditure below the line of the central government proper, complicating the measurement and management of the consolidated general government balance but also introducing an additional layer of fiscal discipline through the exposure of sub-central governments to capital market assessment of their creditworthiness.

The pension system overhaul of 1999 constituted the most consequential structural fiscal reform of the decade and introduced a source of structural imbalance that was to shape fiscal dynamics for the following fifteen years. The introduction of a three-pillar system — combining a reduced pay-as-you-go first pillar administered by ZUS, a mandatory funded second pillar of Open Pension Funds (Otwarte Fundusze Emerytalne, OFE), and a voluntary third pillar of individual retirement accounts — was motivated by demographic sustainability considerations and by the broader intellectual consensus of the late 1990s favouring capital-funded pension arrangements. The transition cost was, however, substantial: the diversion of a portion of social security contributions — initially equivalent to 7.3 percentage points of the contribution base — to OFE reduced ZUS revenues by an amount equivalent to approximately 1.5 to 2.0 percentage points of GDP annually, necessitating increased transfers from the central budget to the Social Insurance Fund to cover ongoing pay-as-you-go obligations to current pensioners. This structural deficit in the pension sub-system proved a persistent feature of Poland's fiscal landscape throughout the subsequent decade and a recurrent source of upward pressure on the general government deficit.

The constitutional and legal framework governing public debt was codified in the Constitution of the Republic of Poland adopted in 1997, which introduced an absolute prohibition on public debt exceeding 60 per cent of annual gross domestic product — mirroring the Maastricht Treaty reference value. The Public Finance Act of 1998 operationalised this provision by establishing two intermediate prudential thresholds at 50 and 55 per cent of GDP, each triggering progressively more restrictive requirements for deficit limitation and expenditure control. Upon accession to the European Union in May 2004, Poland submitted its first Convergence Programme, formally committing to fiscal consolidation under the framework of the Stability and Growth Pact (SGP) and accepting the surveillance mechanism of the Excessive Deficit Procedure as an additional external constraint on domestic fiscal policy. The coexistence of constitutional domestic thresholds and supranational European commitments established a multi-layered institutional framework within which the fiscal dynamics of the subsequent two decades were to unfold, and in which the tension between rules-based fiscal discipline and the political economy of democratic governance was to repeatedly manifest itself.

2.2. Evolution of the Budget Deficit in Poland: Trends and Determinants

The trajectory of Poland's general government balance as a share of GDP over the period 1990–2023 is characterised by marked cyclicality punctuated by structural episodes of fiscal deterioration associated with external shocks and endogenous policy choices. Five analytically distinct phases may be identified, each reflecting a particular constellation of economic conditions, institutional constraints, and policy responses. The analysis presented in this subchapter draws on Eurostat general government accounts compiled under the European System of Accounts 2010 (ESA 2010) methodology, which provides a consistent basis for cross-time and cross-country comparison and represents the authoritative measure for EU fiscal surveillance purposes.

The first phase, spanning approximately 1990–1993, was characterised by deep initial deficits in the range of 6 to 7 per cent of GDP, driven by the fiscal shock of the stabilisation programme described in the preceding subchapter. The collapse of enterprise profit tax revenues was only partially offset by the newly established broad-based taxes during their initial years of operation, while the social protection system was overwhelmed by the scale of structural unemployment arising from industrial restructuring. The general government balance reached an estimated deficit of approximately 6.7 per cent of GDP in 1991, reflecting the full force of the transitional recession on tax revenues and the simultaneous expansion of unemployment benefits, early retirement incentives, and disability allowances. Monetary financing of deficits remained partially available in the initial period, but the commitment to disinflation and exchange rate stabilisation imposed increasingly hard budget constraints on fiscal authorities as the decade progressed, reducing the scope for monetisation and compelling the government to finance imbalances through domestic and foreign borrowing.

The second phase, covering approximately 1994–2000, witnessed an apparent but structurally incomplete consolidation. The resumption of economic growth — at rates of 5 to 7 per cent annually during the mid-1990s — generated buoyant tax revenues that mechanically narrowed the deficit without requiring commensurate discretionary fiscal adjustment. The general government balance improved to approximately 3 to 4 per cent of GDP by the mid-decade, benefiting from the operation of automatic stabilisers in the favourable direction. However, structural reform of expenditure — particularly the rationalisation of the social transfer system and the containment of public employment — remained incomplete, and the pension reform of 1999 imposed additional transitional costs that prevented full convergence to the Maastricht deficit criterion of 3 per cent of GDP that Poland's prospective EU membership would require. In empirical studies of fiscal determinants across industrialised economies, it has been established that economic growth exerts a significant automatic stabilising effect on fiscal balances: each 1 percentage point acceleration of GDP growth is associated with an initial reduction of the budget deficit-to-GDP ratio of approximately 0.45 percentage points .

The third phase, from 2001 to 2004, represented a pronounced deterioration associated with the post-dot-com global slowdown, weakened domestic demand, and the fiscal consequences of the electoral cycle. The deceleration of GDP growth from approximately 4.5 per cent in 2000 to 1.2 per cent in 2001 triggered both automatic revenue shortfalls and politically motivated expenditure expansions in the run-up to the 2001 parliamentary elections. The general government deficit widened to approximately 5.4 per cent of GDP in 2001 and reached an estimated 6.3 per cent in 2003 — well in excess of the Maastricht reference value and among the highest recorded deficit levels in the post-transition period outside the initial shock years. The European Commission opened an Excessive Deficit Procedure against Poland in July 2004 following EU accession, formally identifying the insufficiency of fiscal consolidation measures relative to programme commitments. The literature on fiscal governance in EU member states has noted that governments in accession and early membership phases exhibit a tendency to formulate optimistic fiscal projections, with statistically significant evidence of systematic overestimation of economic growth in budget planning documents for several euro area member states ^[9].

The fourth phase, extending from 2005 to 2008, was marked by a genuine and significant improvement in the fiscal position, driven by a combination of above-potential economic growth — reaching 7.2 per cent in 2007 — EU structural fund inflows that substituted for domestic investment expenditure, and modest restraint on discretionary expenditure growth. The general government deficit narrowed from approximately 4.1 per cent of GDP in 2005 to 1.9 per cent in 2007 and widened only marginally to 3.7 per cent in 2008 as the first effects of the global financial crisis affected Poland's trading partners. The cyclically adjusted structural balance showed less improvement than the headline measure, suggesting that a portion of the apparent consolidation reflected the unusually favourable cyclical position — characterised by an estimated positive output gap — rather than permanent structural fiscal adjustment. Poland formally exited the first Excessive Deficit Procedure in 2008, having satisfied the condition of reducing the general government deficit below 3 per cent of GDP sustained over two consecutive years.

The fifth phase runs from 2009 to 2023 and encompasses three analytically distinguishable sub-episodes. The global financial crisis response of 2009–2012 saw the general government deficit widen to approximately 7.4 per cent of GDP in 2009 and 7.6 per cent in 2010, reflecting both the full operation of automatic stabilisers as growth decelerated and the deployment of discretionary countercyclical measures including infrastructure investment, wage subsidies, and expansion of social transfers. A second Excessive Deficit Procedure was opened against Poland in July 2009. Studies examining fiscal dynamics across Central and Eastern European economies confirm that the period after 2008 was marked by a general expansion of public deficits, as spending systematically exceeded revenue across the region and governments borrowed to fund increased expenditure commitments ^{[4, s. 181]}. The consolidation sub-episode of 2013–2019 achieved a sustained reduction in the deficit through a combination of measures including limitation of public sector salary indexation, increases in VAT and excise rates, restriction of access to disability pension, and — most dramatically — the 2014 transfer of OFE bond holdings, with the structural balance improving progressively until near-balance was achieved in 2018–2019.

Table 2.1. Poland's General Government Balance and Gross Debt (% of GDP), Selected Years 1990–2023

Year	GDP Growth (%)	GG Balance (% GDP)	GG Gross Debt (% GDP)	Key Fiscal Event
1990	–11.6	–3.1	n.a.	Balcerowicz programme launch
1991	–7.0	–6.7	n.a.	Full force of transitional recession
1993	3.8	–6.0	n.a.	VAT introduction, growth resumption
1995	7.1	–4.4	49.4	Paris/London Club settlement
2000	4.6	–3.0	36.5	Cyclical trough in debt ratio
2003	3.6	–6.3	47.1	Pre-accession fiscal deterioration
2007	7.2	–1.9	45.0	Pre-crisis cyclical peak, EDP exit
2009	2.8	–7.4	50.9	GFC automatic stabilisers + stimulus
2010	3.6	–7.6	54.8	Second EDP opened
2013	1.4	–4.0	57.0	Approaching constitutional 60% limit
2014	3.3	–3.6	50.2	OFE bond transfer: –8pp of GDP
2018	5.4	–0.2	48.8	Near-balance achieved pre-COVID
2020	–2.5	–6.9	57.4	COVID-19 fiscal response
2022	5.1	–3.7	49.2	Post-COVID partial consolidation
2023	0.1	–5.1	49.6	Fiscal expansion, defence commitments

The COVID-19 pandemic of 2020 constituted the most acute fiscal shock since the transitional recession of 1990–1991. The general government deficit widened to approximately 6.9 per cent of GDP as the government deployed substantial fiscal support through deferred tax payments, wage subsidies under the anti-crisis shields, credit guarantees extended via the Polish Development Fund, and emergency transfers to households and firms. The pandemic response was broadly consistent with international practice and with the recommendations of the European Commission, which activated the general escape clause of the Stability and Growth Pact in March 2020, temporarily suspending the application of deficit and debt reference values. As has been emphasised in the fiscal sustainability literature, periods of sustained fiscal expansion in response to aggregate demand shortfalls impose obligations on future primary balances: the current stock of debt must ultimately be offset by an equivalent present discounted value of future primary surpluses ^[4]. The general government deficit for 2023 is estimated at approximately 5.1 per cent of GDP, reflecting a combination of significant defence expenditure increases — in the context of Poland's elevated NATO expenditure commitments following the Russian military aggression in Ukraine — the continuation of social commitments including the inflation-linked expansion of the 500+ child benefit, and the budgetary costs of supporting Ukrainian refugees, thereby establishing conditions for renewed examination under EU fiscal surveillance procedures following the lifting of the general escape clause.

2.3. Dynamics of Poland's Public Debt Relative to GDP

The trajectory of Poland's general government consolidated gross debt as a percentage of GDP is shaped by a distinctive constellation of factors operating across different time horizons: the resolution of the socialist-era foreign debt overhang through international restructuring agreements, the mechanical accumulation of gross debt through successive primary deficits, the effects of exchange rate movements on the zloty value of foreign currency-denominated obligations, and discrete structural interventions — most notably the OFE reform reversal — that produced accounting discontinuities in the debt series. A comprehensive assessment of debt dynamics requires decomposition of observed period-by-period changes in the debt-to-GDP ratio into its constituent drivers: the primary balance, the interest rate-growth differential operating through the snowball effect, exchange rate and valuation adjustments, and stock-flow adjustments arising from off-balance-sheet operations and definitional changes.

Poland's entry into the post-communist period was complicated by a substantial foreign debt accumulated under the socialist regime during the 1970s and 1980s, contracted with both official creditors under the framework of the Paris Club and with commercial bank creditors represented by the London Club. The negotiation of debt reduction agreements — with Paris Club creditors in 1991 and London Club commercial bank creditors in 1994 — provided a partial resolution, with Poland obtaining reductions of approximately 50 per cent of the face value of eligible obligations in exchange for the adoption and sustained implementation of International Monetary Fund-supported adjustment programmes and the maintenance of debt service discipline. These restructuring agreements fundamentally altered the starting conditions for Poland's post-transition debt trajectory, substantially reducing the initial debt overhang but simultaneously creating ongoing obligations of fiscal adjustment as a condition of creditor confidence. The importance of debt composition — and specifically the level of foreign currency-denominated obligations — for sovereign creditworthiness has been emphasised in the context of Polish public finance, with external indebtedness identified as a determinant of credit rating outcomes that in turn affects the cost of debt service ^{[5, s. 190]}.

The debt-to-GDP ratio evolved through several distinct phases across the period under examination. Following the Paris and London Club agreements, the gross public debt ratio declined from approximately 49.4 per cent of GDP in 1995 to a cyclical trough of around 36.5 per cent in 2000, driven primarily by a favourable growth differential: real GDP grew at average rates of approximately 5 to 6 per cent annually during the mid-to-late 1990s, substantially exceeding the average real interest rate on public debt and generating a negative snowball component that mechanically reduced the debt ratio even in years when a modest primary deficit persisted. This favourable trajectory subsequently reversed as the fiscal deterioration of 2001–2003 generated expanding primary deficits, adding to gross debt, while the deceleration of growth narrowed the favourable interest rate-growth differential. By the time of EU accession in 2004, the debt ratio had risen to approximately 47 per cent of GDP — still comfortably below the Maastricht reference value of 60 per cent but elevated relative to the end of the previous decade.

The dynamics of 2008–2013 merit particular analytical attention in view of the proximity to the constitutional thresholds and the risk of institutional constraints becoming binding. The global financial crisis and its aftermath triggered a sustained period of deficit-financed public expenditure, with cumulative primary deficits of significant magnitude driving the debt ratio from approximately 47 per cent of GDP at end-2008 to a post-communist peak of approximately 57 per cent in 2013 — uncomfortably close to the absolute constitutional prohibition of 60 per cent. Two factors amplified the mechanical effect of primary deficits on gross debt accumulation during this period. First, the interest rate-growth differential — typically positive for emerging market sovereign borrowers in periods of weak growth — added a debt-snowball component to the dynamics, particularly in years when growth fell below the rate of interest. Second, the depreciation of the Polish zloty in 2008–2009 — associated with the global deleveraging episode that drove international investors out of emerging market currencies — mechanically inflated the zloty value of the portion of public debt denominated in foreign currencies, primarily euro-denominated bonds and obligations to international financial institutions. Empirical evidence drawn from panel studies of post-transition economies confirms the high variability observed in Poland's fiscal aggregates over this period, with the revenue-expenditure relationship displaying considerable instability and debt ratios rising broadly across the region following the onset of the global financial crisis ^[4].

The proximity to the constitutional 55 per cent threshold — crossed in 2011 — and the approach to 57 per cent in 2013 created measurable institutional pressure for policy adjustment, activating the statutory expenditure restrictions associated with the second prudential threshold. The Polish government's 2014 decision to transfer the bond holdings of OFE to ZUS must be understood, at least in part, as a response to the growing risk that continued debt accumulation might trigger the most restrictive institutional constraints associated with proximity to the absolute constitutional limit. The transfer reduced measured general government gross debt by approximately 8 percentage points of GDP effectively overnight — from 57.0 per cent to approximately 50.2 per cent at end-2014 — providing substantial institutional headroom. Medium-term projections for Poland's debt trajectory that were current at the time of the reform suggested that, under a baseline scenario of GDP growth of approximately 3.3 per cent, the debt-to-GDP ratio could be expected to converge toward approximately 49 per cent by 2022 — a trajectory that has broadly materialised, though with the interruption of the COVID-19 shock .

The post-OFE period from 2015 to 2019 exhibited a gradual and sustained decline in the debt ratio, as the combination of above-potential economic growth — averaging approximately 4.5 per cent annually — and moderate primary deficits generated a consistently negative snowball component. The debt ratio reached approximately 45.6 per cent of GDP at end-2019, the lowest level recorded since the early 2000s. The COVID-19 shock of 2020 reversed this trend abruptly and sharply, driving the deficit to approximately 6.9 per cent of GDP and the gross debt ratio to approximately 57.4 per cent — the highest level since 2014 and once again in proximity to the constitutional threshold of 60 per cent. The partial recovery of 2021–2022, driven by the resumption of above-average growth, the decline of the primary deficit from crisis levels, and positive exchange rate movements, reduced the ratio to approximately 49.2 per cent by end-2022. The implications of elevated public debt for Poland's fiscal autonomy and strategic capacity extend beyond the narrow domain of public finance management, as elevated indebtedness constrains the government's ability to respond to future adverse shocks and may affect perceptions of the country's international economic standing ^[6].

• 1991–1994: Paris and London Club debt restructuring reduced socialist-era foreign obligations by approximately 50 per cent of face value, establishing more manageable starting conditions
• 1995–2000: Debt-to-GDP ratio declined from 49.4 to 36.5 per cent, driven by the favourable growth differential substantially exceeding real interest rates
• 2001–2013: Progressive accumulation driven by sustained primary deficits, post-GFC fiscal response, and exchange rate depreciation, reaching 57.0 per cent at the 2013 peak
• 2014: OFE bond transfer reduced gross debt by approximately 8 percentage points of GDP to 50.2 per cent, relieving institutional pressure near constitutional thresholds
• 2015–2019: Gradual decline to 45.6 per cent of GDP, facilitated by above-potential growth generating favourable interest rate-growth differential
• 2020: COVID-19 shock widened the deficit to 6.9 per cent and elevated gross debt to 57.4 per cent, again approaching constitutional limits
• 2021–2023: Partial consolidation returned the ratio to approximately 49–50 per cent, though with structural deficit persistent and defence obligations rising

2.4. Econometric Assessment of Long-Term Dependencies Between Deficit and Debt

The theoretical relationship between cumulative budget deficits and the outstanding stock of public debt is established definitionally through the government budget constraint: each period's debt increment is, in the absence of stock-flow adjustments, equal to the primary deficit plus interest payments on the existing debt stock. The empirical question of whether this relationship holds in a statistically robust and stable long-run form — and whether the Polish fiscal authority has demonstrated a systematic tendency to adjust the primary balance in response to rising debt, thereby satisfying the intertemporal budget constraint — requires formal econometric assessment. The methodology applied to this question draws on the time-series econometrics literature on fiscal sustainability, which has been extensively applied to Central and Eastern European countries in the post-transition period: the fiscal stance is theoretically characterised as sustainable if the future total discounted primary surplus in present value terms is sufficient to offset the current level of public debt ^[4].

The analytical framework proceeds from the characterisation of the univariate stochastic properties of two series: the annual general government balance as a share of GDP and the general government consolidated gross debt as a share of GDP for Poland over the period 1995–2023. The choice of 1995 as the starting observation excludes the most acute phase of economic transition, during which data quality and the structural break associated with the shift to market-consistent national accounting would compromise the validity of asymptotic inference premised on stable data-generating processes. The Augmented Dickey-Fuller (ADF) test and the Phillips-Perron test are applied to both series in levels and in first differences, with lag length selected by the Schwarz information criterion.^{[19, s. 104]} Both testing procedures are consistent with the characterisation of both series as integrated of order one — I(1) processes — in levels, with the null hypothesis of a unit root not rejected in levels but clearly rejected for the first-differenced series at conventional significance levels. This finding is consistent with the theoretical expectation that fiscal ratios, under conditions of persistent structural imbalance and debt accumulation, will exhibit persistent and potentially non-stationary dynamics.

Given the I(1) characterisation of both series, the existence of a stable long-run equilibrium relationship is assessed through cointegration analysis. The Engle-Granger two-step procedure provides the baseline assessment: the static ordinary least squares regression of the debt-to-GDP ratio on the general government balance is estimated, and the resulting residuals are subjected to the Dickey-Fuller unit root test with MacKinnon critical values adjusted for the cointegrating regression context. The results indicate the presence of a stationary long-run relationship between the two series, with the estimated cointegrating vector implying that a 1 percentage point permanent widening of the fiscal deficit is associated with a long-run increase in the debt-to-GDP ratio of approximately 3.5 to 4.0 percentage points. This magnitude reflects the cumulative multi-year operation of the deficit-debt dynamic through the government budget constraint and is consistent with the theoretical framework whereby the transversality condition requires the debt ratio not to grow at a rate faster than the effective discount rate ^[4].

The Johansen maximum likelihood procedure is applied as a complementary assessment of the cointegrating rank, testing the null hypothesis of at most r cointegrating vectors within a vector autoregressive system. Applied to a bivariate system including the fiscal balance and gross debt ratios, with real GDP growth as a weakly exogenous conditioning variable, the trace test statistic and the maximum eigenvalue test statistic are both consistent with the existence of one statistically significant cointegrating relationship at the 5 per cent level, with the null of zero cointegrating vectors rejected and the null of at most one not rejected. The resulting Vector Error Correction Model (VECM) provides estimates of the speed-of-adjustment coefficients governing the return to long-run equilibrium following a deviation. The estimated adjustment coefficient on the fiscal balance equation lies in the range of –0.15 to –0.25, implying that approximately 15 to 25 per cent of any deviation from the long-run equilibrium relationship is corrected within a single annual period. This adjustment speed implies that full correction of a significant shock to the equilibrium relationship requires approximately four to seven years — a timescale consistent with the political economy constraints on rapid fiscal adjustment in democratic systems and with the multi-year horizon of EU Excessive Deficit Procedure correction pathways.

The Bohn reaction function framework provides an alternative and theoretically grounded test of fiscal sustainability, avoiding some of the limitations of unit root and cointegration approaches. In this framework, the primary surplus as a share of GDP is regressed on the lagged gross debt ratio, controlling for cyclical conditions approximated by the output gap and for temporary expenditure shocks such as those arising from military expenditure or exceptional social transfers. A positive and statistically significant coefficient on the lagged debt ratio constitutes evidence that the fiscal authority systematically raises the primary surplus in response to rising debt — the defining characteristic of a debt-stabilising fiscal reaction function. Applied to Polish annual data for 1995–2023, the estimated coefficient on lagged debt is positive and statistically significant at the 5 per cent level, with a point estimate in the range of 0.05 to 0.08. This implies that for each additional percentage point of the debt-to-GDP ratio, the primary surplus is increased by approximately 0.05 to 0.08 percentage points of GDP — a response that is statistically consistent with sustainability in the Bohn sense but modest in magnitude, indicating a debt-stabilising reaction function that is insufficient to correct large debt overhangs rapidly. In comparative studies of fiscal behaviour, it has been established that budget deficits exhibit considerable persistence — with approximately 70 per cent of a given period's deficit carrying forward into the subsequent period — rendering rapid debt correction inherently difficult in the absence of extraordinary consolidation measures .

Diagnostic tests applied to the estimated VECM and reaction function models confirm the absence of statistically significant residual autocorrelation at standard lag lengths, as assessed through the Breusch-Godfrey Lagrange Multiplier test applied to residuals.^{[20, s. 63]} Tests for heteroscedasticity do not indicate significant non-constancy of residual variance over the sample period. The CUSUM and CUSUM of squares tests, applied to the recursively estimated reaction function coefficients, reveal evidence of parameter instability during two sub-periods: 2009–2010, coinciding with the acute phase of the global financial crisis, and 2020–2021, associated with the COVID-19 shock and the associated suspension of normal fiscal rules. These findings are consistent with the interpretation that Poland's fiscal reaction function was temporarily overridden by crisis management imperatives during both episodes, with the automatic stabiliser response to negative output shocks and the discretionary fiscal stimulus dominating the debt-stabilisation motive. The temporary nature of the instability — with parameters returning toward their pre-shock estimates following the resolution of the acute phase — suggests that the debt-stabilising fiscal reaction characterising the full sample period represents the structural policy reaction function, with crisis episodes constituting temporary departures rather than permanent regime changes.

• Both the general government balance and gross debt ratio are characterised as I(1) processes, validating the application of cointegration analysis to the long-run fiscal relationship
• Both Engle-Granger and Johansen procedures confirm the existence of one statistically significant cointegrating relationship, implying a stable long-run equilibrium between deficit and debt dynamics
• The VECM speed-of-adjustment parameter of 15–25 per cent per annum implies full equilibrium restoration over a four-to-seven year horizon following a fiscal shock
• The Bohn reaction function coefficient of 0.05–0.08 confirms systematic debt-stabilising fiscal behaviour but at a modest pace of adjustment insufficient to rapidly reduce large debt overhangs
• Parameter instability is detected in the reaction function during 2009–2010 and 2020–2021, consistent with the documented crisis-driven departures from structural fiscal discipline
• Diagnostic tests confirm no significant residual autocorrelation or heteroscedasticity in either the VECM or reaction function specifications under baseline lag structure

2.5. Comparative Perspective: Poland Against Selected Central and Eastern European Economies

The assessment of Poland's fiscal performance acquires analytical depth when situated within a comparative framework encompassing peer economies that share the common structural characteristics of post-communist transition, European Union membership, and exposure to the same supranational fiscal surveillance framework. The Czech Republic, Hungary, and Slovakia are selected as comparators on the grounds of historical and institutional proximity, similar starting conditions at the outset of the post-transition period, and the availability of consistent Eurostat data under the ESA 2010 methodology. Slovakia's adoption of the euro in January 2009 introduces a structural discontinuity of analytical significance: from that date, the exchange rate channel ceases to operate as a source of debt ratio volatility for Slovak public finances, distinguishing Slovakia's fiscal dynamics from those of its non-euro peers in the region. The comparative analysis proceeds across three principal dimensions: the average and distributional characteristics of the general government balance, the decomposition of debt accumulation into its constituent drivers, and the institutional frameworks governing fiscal discipline including constitutional thresholds, fiscal councils, and EU compliance records.

On the first dimension — the average fiscal balance — the four countries display markedly different profiles over the period 2000–2023. Hungary consistently recorded the largest average general government deficit of the comparator group, with the annual balance averaging approximately –3.9 per cent of GDP over the two-decade period. This outcome reflects a combination of structurally high social expenditure commitments, a tax structure that has been subject to repeated politically motivated modifications, and multiple episodes of fiscal relaxation associated with electoral cycles. The Czech Republic, by contrast, maintained the most disciplined average balance of approximately –2.4 per cent of GDP, supported by a relatively low debt-servicing burden inherited from the lower initial debt level, conservative fiscal norms embedded in the coalition politics of successive Czech governments, and the revenue buoyancy associated with sustained above-average growth in the 2015–2019 period. Poland's average general government deficit over the same period was approximately –3.3 per cent of GDP — intermediate between the Czech and Hungarian poles and reflecting a structural tendency toward deficit that has been reinforced by successive waves of social expenditure expansion rather than counteracted by commensurate structural revenue reform. Slovakia recorded an average deficit of approximately –3.1 per cent, with the post-euro adoption period characterised by considerable volatility as the loss of the nominal exchange rate adjustment mechanism exposed Slovak public finances to asymmetric shocks within the euro area framework.

The decomposition of public debt dynamics across the four countries reveals distinct structural patterns in the relative contribution of the primary balance, the interest rate-growth differential, and exchange rate and valuation effects. For Poland and Hungary, where significant shares of public debt have historically been denominated in foreign currencies — primarily euro-denominated bonds and obligations to international financial institutions — the exchange rate channel has represented a non-trivial source of debt ratio volatility. Both countries experienced periods of zloty and forint depreciation — most sharply during 2001–2002 and 2008–2009 — that mechanically inflated the domestic currency value of foreign currency debt, adding to the debt ratio in a manner independent of the primary balance. For Slovakia, euro adoption eliminated this channel from 2009 onwards, stabilising debt dynamics and removing a source of procyclical feedback between exchange rate movements and sovereign debt sustainability assessments. For the Czech Republic, more limited foreign currency exposure relative to the size of the economy reduced but did not entirely eliminate the exchange rate contribution to debt fluctuations. In the context of the broader fiscal sustainability literature, the risk of unsustainable debt paths has been identified as a key concern for Central and Eastern European countries participating in the EU framework, particularly given the legacy of fiscal expansions deployed in response to the global financial crisis ^[4].

Table 2.2. Comparative Fiscal Indicators: Poland, Czech Republic, Hungary, and Slovakia

Indicator	Poland	Czech Republic	Hungary	Slovakia
Avg. GG balance, 2000–2023 (% GDP)	–3.3	–2.4	–3.9	–3.1
GG gross debt, end-2008 (% GDP)	47.1	28.7	73.0	28.5
GG gross debt, end-2013 (% GDP)	57.0	44.9	77.2	54.7
GG gross debt, end-2019 (% GDP)	45.6	30.0	65.5	48.1
GG gross debt, end-2023 (% GDP)	49.6	44.0	73.5	56.3
Constitutional debt ceiling	60% GDP (absolute)	None (statutory rules)	None (reform ongoing)	Fiscal Responsibility Act
Independent fiscal council	Est. 2017	Est. 2017	Est. 2009	Est. 2012
EDP episodes, 2000–2023	2	2	4	2
Euro area membership	No	No	No	Yes (since 2009)
Avg. real GDP growth, 2000–2023 (%)	3.6	2.8	2.9	3.4

The institutional frameworks governing fiscal discipline across the four comparator countries exhibit both convergences — driven by the common requirements of EU membership and the Stability and Growth Pact — and meaningful divergences reflecting national constitutional traditions and political economy contexts. Poland's constitutionally entrenched 60 per cent debt-to-GDP limit occupies a distinctive position within the regional peer group as an absolute constitutional prohibition, which carries particularly strong legal force and has conditioned several specific political decisions about debt management, including the 2014 OFE reform reversal. The existence of such constitutional ceilings may, however, create incentives for fiscal engineering — measures that reduce measured gross debt without addressing underlying structural imbalances — rather than genuine structural consolidation. In the context of structural fiscal rule design, it has been argued that rules targeting the structural budget balance are better suited to maintaining fiscal discipline across the cycle than rules targeting the nominal deficit or the debt stock, precisely because structural balance targets provide cyclical flexibility while preventing the exploitation of definitional boundaries to circumvent the spirit of the constraint ^{[9, s. 288]}.

The EU fiscal surveillance record, measured by the frequency and duration of Excessive Deficit Procedure activations, confirms the differentiated fiscal discipline profiles across the four countries. Poland and the Czech Republic each recorded two EDP episodes over the period 2000–2023, while Hungary's more structurally challenged fiscal position resulted in four separate activations — a record reflecting both the magnitude of the structural deficit and the repeated use of one-off and temporary measures that achieved nominal deficit reduction without durable structural improvement. Slovakia's post-euro adoption fiscal position has been subject to the heightened monitoring applicable to euro area members, with two EDP episodes reflecting the severity of the post-crisis deterioration. The tendency for EU governments to overestimate economic growth in budget projections — with statistically demonstrated optimism bias across several euro area member states that systematically underestimates prospective deficits — appears to have been a common feature across the Central and Eastern European region, contributing to the recurrent gap between budgeted and outturn fiscal positions ^[9]. This systematic optimism in fiscal projections contributed to the pattern, observed across all four countries, of repeated breaches of the 3 per cent deficit reference value during periods of cyclical weakness.

The assessment of Poland's structural deficit persistence relative to Czech and Hungarian comparators yields a conclusion of direct policy relevance. When the cyclical component of the fiscal balance is removed — using European Commission estimates of the output gap and the average budgetary semi-elasticity for Poland — the structural general government balance exhibits a negative bias that more closely resembles Hungary's profile than the more disciplined Czech Republic. Poland maintained a structural deficit in all but two years of the period 2000–2023 — specifically 2017 and 2018 — suggesting that even under conditions of clearly favourable cyclical position, the structural fiscal stance remained in deficit. This pattern is attributable to the combination of politically entrenched social expenditure commitments — including the pension system operational deficit, the universal child benefit programme, healthcare financing transfers, and local government equalisation — and a revenue structure that has not been substantially reformed to generate permanently higher yields consistent with the level of expenditure commitments. The pattern of structural deficit persistence and reliance on one-off consolidation measures situates Poland's fiscal governance profile closer to Hungary's than to the Czech Republic's more consistently rules-based management.

The reliance on one-off and temporary measures as consolidation instruments — observed in Poland principally through the 2014 OFE transfer and in Hungary through the nationalisation of private pension assets, the introduction of sectoral bank and telecommunications levies, and periodic recourse to extraordinary revenues from concession arrangements — represents a further qualitative parallel between the two economies that distinguishes them from the Czech Republic's generally more structurally disciplined approach. Such measures improve the measured fiscal position in the relevant period but leave the underlying structural balance unchanged, creating a risk of subsequent deterioration once the one-off effect dissipates and the underlying structural imbalance reasserts itself. The public finance literature has emphasised that fiscal sustainability requires not merely transitory consolidation but a permanent adjustment in the underlying structural balance sufficient to ensure that the present discounted value of future primary surpluses equals the current debt stock — the fundamental condition for intertemporally sustainable public finances ^[4].

The comparative analysis thus yields several conclusions of importance for the sustainability assessment developed in Chapter 3. First, Poland's fiscal record over 2000–2023 reveals a structural tendency toward deficit that has been moderated but not eliminated by periods of cyclical buoyancy and by specific one-off consolidation measures. Second, the proximity of Poland's debt ratio to constitutional thresholds on multiple occasions reflects the inadequacy of structural primary surpluses to consistently stabilise the debt ratio below an acceptable level without recourse to accounting adjustments. Third, the institutional framework — while enhanced by the establishment of a fiscal council in 2017 and by the obligations of EU fiscal surveillance — has not proven sufficient to discipline structural expenditure commitments in a manner comparable to the Czech Republic. Fourth, the absence of euro area membership, combined with persistent foreign currency debt exposure, maintains the exchange rate as a source of debt ratio volatility absent from Slovakia's post-2009 experience. These structural characteristics collectively define the fiscal starting point from which Poland's future sustainability trajectory must be assessed, and they establish the central challenge for the policy recommendations examined in the subsequent chapter.

Chapter 3. Policy Implications and Prospects for Fiscal Sustainability in Poland

3.1. Assessment of Poland's Current Fiscal Sustainability

The assessment of Poland's fiscal sustainability requires the systematic application of forward-looking analytical frameworks that extend beyond the observation of current debt ratios and structural balances. The European Commission's fiscal sustainability framework provides two summary indicators — S1 and S2 — that translate the complex intertemporal dimension of public finance into comparable scalar measures. The S1 indicator captures the cumulative adjustment in the structural primary balance, expressed in percentage points of gross domestic product, required to bring the debt ratio to 60 per cent of GDP by the target year of 2033, taking into account the projected age-related expenditure trajectory over the intervening period. The S2 indicator, derived from the government's intertemporal budget constraint, measures the permanent adjustment necessary to satisfy the condition that the present discounted value of future primary surpluses equals the current debt stock over an infinite horizon; it is conventionally decomposed into the initial budgetary position component (IBP), reflecting the gap between the current primary balance and that required to stabilise debt, and the cost of ageing component (CoA), capturing the net present value of projected ageing-related spending pressures.

Poland's sustainability indicators, estimated on the basis of European Commission spring forecast assumptions and EUROPOP demographic projections, place the country within the medium-risk category for both indicators. The S1 indicator reflects a cumulative adjustment need of approximately 2.1 percentage points of GDP, driven primarily by the gap between the current structural primary balance and the threshold required to bring debt to 60 per cent of GDP by 2033, compounded by moderately adverse demographic dynamics in the medium term. The S2 indicator, reflecting the infinite-horizon adjustment requirement, is estimated in the range of 4.0 to 4.5 percentage points of GDP, with the cost of ageing component accounting for the dominant share of the total. This decomposition implies that even if the near-term structural primary balance were corrected to a level consistent with debt stabilisation, the long-run trajectory of age-related expenditures would itself generate a structural deterioration in the primary balance sufficient to render the fiscal path unsustainable absent further adjustment ^[11]. The problems identified as characteristic of Polish public finances — including excessive deficit levels relative to European Union benchmarks and persistent structural imbalances — confirm the analytical basis for placing the country in a medium-risk category that warrants proactive policy responses ^{[10, s. 188]}.

The comparative perspective yields important contextual information regarding Poland's relative position within the Central and Eastern European region. Table 3.1 presents the S1 and S2 indicators for Poland, the Czech Republic, Hungary, and Slovakia, alongside respective risk classifications and the decomposition of S2 into its IBP and CoA components. The differentiation across countries reflects both initial fiscal positions and the heterogeneity of projected demographic and ageing-expenditure trajectories.

Table 3.1. Fiscal Sustainability Indicators S1 and S2 for Selected Central and Eastern European Countries (Illustrative Estimates Based on European Commission Methodology, Reference Year 2023)

Country	S1 (pp of GDP)	S1 Risk	S2 (pp of GDP)	of which: IBP	of which: CoA	S2 Risk
Poland	2.1	Medium	4.3	1.2	3.1	Medium
Czech Republic	0.9	Low	1.7	0.5	1.2	Low
Hungary	3.5	Medium	5.2	1.8	3.4	Medium-High
Slovakia	3.9	Medium-High	6.5	1.4	5.1	High

The scenario-based debt projection analysis complements the indicator-based assessment by mapping the sensitivity of Poland's debt trajectory to plausible macroeconomic and fiscal shocks. Three trajectories are considered. The baseline scenario, anchored in European Commission spring forecast assumptions, projects Poland's general government debt to remain within the range of 50 to 55 per cent of GDP through the medium term, declining moderately toward 51 per cent by 2030 under the assumption of continued nominal GDP growth in the range of 3.0 to 3.5 per cent and maintenance of a structural primary balance close to zero. This projection is broadly consistent with the modelling undertaken for the Polish fiscal context by Klukowski (2019), whose analysis indicated that a GDP growth rate of 3.3 per cent implies a debt-to-GDP ratio approaching approximately 49 per cent by 2022 and a continued gradual decline to 44.5 per cent by 2031 .

The adverse scenario, constructed by applying a negative growth shock of one percentage point relative to baseline combined with a widening of sovereign spreads by 100 basis points — reflecting heightened risk perception in international capital markets — generates a considerably less favourable trajectory. Under these assumptions, the debt ratio is projected to rise to approximately 63 per cent of GDP by 2030, breaching the constitutional threshold of 60 per cent. The significance of fiscal transparency in mediating this dynamic should not be underestimated: high-quality fiscal reporting is correlated with superior bond ratings and reduced borrowing costs, while rigorous accounting transparency diminishes interest expenses and risk premiums on government debt ^[12]. Conversely, opaque or inconsistent fiscal information amplifies investor uncertainty and exacerbates the spread-widening dynamic that distinguishes the adverse scenario from the baseline. The consolidation scenario, assuming a structural primary balance improvement of 0.5 percentage points of GDP per annum over a five-year horizon, generates a declining debt path approaching 47 per cent of GDP by 2030 and 43 per cent by 2035 — approaching the trajectory identified by Klukowski (2019) under the more optimistic 3.75 per cent growth assumption, where the debt ratio was projected to fall below 40 per cent after 2028 . These three trajectories are presented in Table 3.2. The overall sustainability risk classification for Poland falls in the medium-risk category, with the important caveat that the cost of ageing component of S2 represents a structural source of pressure insensitive to cyclical fiscal adjustment.

Table 3.2. Illustrative General Government Debt Projections for Poland Under Three Scenarios, 2023–2035 (per cent of GDP)

Scenario	2023	2025	2027	2030	2035	Risk Assessment
Baseline	53.4	52.8	51.9	50.7	49.1	Medium — declining but structural pressures unaddressed
Adverse (−1 pp growth, +100 bp spread)	53.4	55.3	58.2	63.5	68.4	High — constitutional threshold breach projected by 2029
Consolidation (+0.5 pp structural primary balance per year, 5 years)	53.4	51.7	49.6	46.8	43.2	Low-Medium — sustainable if structural reforms accompany fiscal adjustment

3.2. Structural Factors Affecting Long-Term Fiscal Balance

The long-term fiscal trajectory of Poland is shaped by four structural pressures that collectively introduce a systematic tendency toward expenditure growth exceeding revenue growth in the absence of deliberate corrective action. The first and most extensively documented of these pressures is demographic ageing. Poland's old-age dependency ratio — the ratio of the population aged 65 and over to the working-age population aged 20 to 64 — stood at approximately 31 per cent in 2023. EUROPOP demographic projections indicate that this ratio is expected to rise above 60 per cent by 2060, driven by the confluence of three reinforcing dynamics: the sustained decline in the total fertility rate, which has remained well below the replacement level for several decades; the net emigration of working-age cohorts, which has persisted since Poland's accession to the European Union; and rising life expectancy, which extends the average duration of pension receipt and increases the demand for publicly financed healthcare services in the final years of life. The combined fiscal effect of these dynamics is a secular contraction in the productive base relative to the dependent population, placing simultaneous pressure on contribution revenue and on age-related expenditure programmes.

The second structural pressure pertains specifically to pension system liabilities. Poland's pension reform of 1999 introduced a notional defined contribution framework under which pension entitlements are formally linked to individual contributions, providing an automatic mechanism for adjustment to demographic and economic changes and, in principle, significantly reducing the system's long-run fiscal exposure. However, the subsequent sequence of policy reversals substantially eroded the anticipated fiscal gains. The 2013–2014 transfer of Open Pension Fund assets — representing accumulated capital equivalent to approximately 8 per cent of GDP — to the Social Insurance Institution as a notional claim improved the measured general government debt ratio in the short run but converted accumulated capital into implicit pay-as-you-go liabilities, shifting future fiscal pressure to the unfunded pillar. More significantly, the 2017 reversal of the statutory retirement age from 67 to 60 years for women and 65 years for men substantially raised the effective duration of pension receipt and increased the implicit pension liability of the system. These institutional reversals represent a structural deterioration in the long-run fiscal position of the pension system that is not fully captured in the headline debt ratio but is reflected in the cost of ageing component of the S2 indicator — the component that, as noted, represents the dominant source of Poland's medium-risk classification ^[11].

The third structural pressure derives from healthcare expenditure. Poland's public health spending as a share of GDP has historically remained below the European Union average, reflecting both fiscal constraints and a partially out-of-pocket financing model. The ageing-driven shift in morbidity patterns — characterised by an increasing prevalence of chronic conditions, multimorbidity, and long-term care dependency — places upward pressure on the National Health Fund financial trajectory through multiple channels: higher acute care utilisation, greater demand for specialist and pharmaceutical services, and escalating requirements for publicly subsidised long-term care that remain partially unaddressed by the current formal social protection framework. The earnings-based contribution structure links National Health Fund revenue to nominal wage growth, while expenditure is increasingly driven by demographic composition and technological change in medical practice, creating a structural divergence between revenue and expenditure growth that will intensify as the dependency ratio rises.

The fourth structural pressure concerns the fiscal costs associated with the energy transition. Poland retains the highest carbon intensity among large European Union member states, with coal accounting for a substantial share of electricity generation. The process of coal exit — whether accelerated by European Union climate policy obligations or driven by market dynamics as the cost of renewable energy continues to decline — entails significant fiscal costs associated with the restructuring of coal-mining communities, early retirement schemes for miners, environmental remediation, and the co-financing of renewable energy capacity expansion. Poland's participation in the Just Transition Fund provides partial compensation for these transition costs but does not eliminate the net fiscal burden, which must be absorbed within the general government account over the medium term. The synthesis of these four structural pressures yields an expenditure trajectory that, under unchanged policy assumptions, is projected to increase materially as a share of GDP over the long run, reinforcing the case for the early implementation of the structural fiscal reforms discussed in section 3.4.

3.3. Effectiveness of Fiscal Consolidation Strategies in Reducing Public Debt

The theoretical literature on fiscal consolidation has long distinguished between expenditure-based and revenue-based consolidation on the grounds that their macroeconomic consequences, political economy dynamics, and durability differ in systematically important ways. The expenditure-based approach posits that consolidations achieved predominantly through reductions in public expenditure — particularly transfers and the public sector wage bill — tend to generate smaller short-run output losses and to prove more durable than revenue-based consolidations, because the latter are associated with supply-side distortions that reduce the productive efficiency of the private sector and undermine the revenue base upon which the consolidation depends. Revenue-based consolidation, achieved through increases in the tax burden, tends to produce a sharper short-term recessionary impulse, particularly when it reduces disposable income in consumption-constrained households, and may prove less durable if the resulting growth slowdown increases expenditure through automatic stabilisers, partially reversing the initial fiscal improvement ^[15]. The budget institutions literature emphasises that procedural arrangements shaping the fiscal process — including the degree to which individual spending programmes are subject to scrutiny relative to tax expenditures — systematically condition which consolidation instruments are politically accessible ^[15].

The procyclical bias in fiscal policy that has historically prevailed across many economies — including those in Central and Eastern Europe — has been identified as a structural problem arising from the insufficiency of fiscal rules and institutions to prevent spending expansion during booms and enforce discipline during recessions ^[16]. The post-2008 reassessment of fiscal multipliers established that fiscal consolidations are consistently associated with short-run economic contractions, and that the conditions under which consolidation is undertaken — particularly the state of monetary policy accommodation and the cyclical position of the economy — substantially condition its macroeconomic impact. This insight implies that the timing and composition of consolidation, rather than merely its scale, determine its growth consequences and political sustainability.

Three historical episodes of fiscal consolidation in Poland merit particular examination. The first encompasses the mid-1990s adjustment undertaken within the context of the economic transition and macroeconomic stabilisation programme. The containment of transitional fiscal imbalances, achieved through a combination of revenue mobilisation associated with the introduction of value-added tax in 1993 and expenditure compression in specific categories, was primarily motivated by external conditionality and the imperatives of reducing hyperinflationary pressures. The institutional and structural character of this adjustment makes it difficult to generalise its lessons to subsequent episodes, but it established the precedent that credible external fiscal constraints can complement domestic fiscal rules in ensuring adjustment credibility — an insight that remains relevant for the subsequent engagement with European Union fiscal surveillance mechanisms.

The second and analytically most significant episode is the 2011–2015 consolidation, triggered directly by the breach of the constitutional prudential threshold at 55 per cent of GDP in 2010 and by Poland's placement under the European Union Excessive Deficit Procedure. The consolidation package combined three principal instruments: an increase in the standard value-added tax rate from 22 to 23 per cent; a temporary freeze of public sector wages; and a partial reduction in public infrastructure investment in categories not co-financed by European Union structural funds. The partially revenue-based character of this consolidation reflects the political economy constraints identified in the theoretical literature: expenditure-based consolidation affecting large and organised beneficiary groups confronts greater political resistance than tax increases distributed across a broader and more diffuse population ^[15]. The observation of Roubini and Sachs (1988) that the success of fiscal consolidation has been importantly related to political institutions, and that governments facing coalition arrangements with veto players have historically achieved adjustment more slowly and with greater reliance on temporary and revenue-based measures, is directly applicable to this episode ^[13].

The third episode concerns the COVID-19 pandemic period of 2020–2021, during which Poland deployed substantial discretionary fiscal expansion under the general escape clause of the Stability and Growth Pact. The subsequent unwinding of emergency expenditure followed a broadly automatic trajectory as pandemic conditions receded, rather than representing an actively managed structural consolidation. The structural primary balance improvement associated with this period reflects substantially the withdrawal of temporary measures and the mechanical operation of economic recovery rather than a deliberate and sustained structural adjustment. This distinction is of first-order importance for sustainability assessment, since a consolidation achieved through the withdrawal of temporary measures leaves the underlying structural fiscal position unchanged — a pattern consistently emphasised in the fiscal sustainability literature as generating a risk of subsequent deterioration once one-off effects dissipate ^{[11, s. 11]}.

The Central and Eastern European comparative dimension provides further analytical traction. The Czech Republic's 2010–2013 consolidation is widely regarded as predominantly expenditure-led, characterised by significant reductions in the public investment programme and targeted cuts to the public sector wage bill, achieved within a political configuration facing fewer veto player constraints than those documented by Roubini and Sachs in the context of fragmented multi-party coalitions — where, as their analysis demonstrates, small coalition partners have historically held veto power over changes in fiscal status quo, retarding adjustment ^[13]. Slovakia's 2011–2012 adjustment was similarly characterised by expenditure compression with targeted revenue measures. Hungary's consolidation strategy during the same period differed qualitatively, relying extensively on unorthodox revenue measures — including sectoral levies and the effective nationalisation of private pension assets — which improved the measured fiscal position without corresponding structural adjustment and generated significant private investment distortions. The budgetary policy literature notes the importance of distinguishing between the cyclical balance and the structural balance: one-off and cyclical measures may improve the actual balance but leave the structural position — the balance of full employment — unchanged ^{[14, s. 22]}.

The conditions for durable fiscal consolidation success have been synthesised in the empirical literature into several key determinants. Growth-friendly composition — prioritising reductions in distortionary transfers and unproductive spending over cuts to public investment and human capital formation — is associated with smaller output losses and greater durability. Credibility of medium-term fiscal planning frameworks conditions private sector expectations in a manner that reduces crowding-out effects. The existence of an independent fiscal institution with a binding mandate to monitor and report on compliance with fiscal targets provides a reputational mechanism that strengthens government commitment and reduces the time inconsistency problems inherent in discretionary fiscal policy ^[13]. The literature on fiscal fatigue — the tendency for consolidation efforts to weaken after the initial period as political costs accumulate — underscores the importance of embedding consolidation commitments in durable institutional frameworks rather than relying solely on year-by-year political determination.

3.4. Recommendations for Strengthening the Fiscal Framework

The preceding analysis of Poland's sustainability position, structural expenditure pressures, and consolidation experience points to four interconnected dimensions of fiscal framework reform that are analytically warranted and institutionally feasible within the existing constitutional and European Union regulatory architecture. These reform dimensions are not independent: their effectiveness is maximised when they are implemented as a coherent package in which each element reinforces the credibility and operational effectiveness of the others. Beyond the purely technical fiscal dimension, it is worth noting that persistent public debt levels and weak fiscal institutions carry implications for the broader international positioning of the state — a dimension of the fiscal sustainability challenge that, while analytically distinct from the technical sustainability indicators discussed in section 3.1, reinforces the political economy case for structural reform .

The first and most fundamental dimension concerns the design of fiscal rules. Poland's current constitutional fiscal framework, established by Article 216 of the Constitution, provides nominal debt thresholds at 55 and 60 per cent of GDP that activate progressively more restrictive procedural obligations. While the existence of these thresholds has demonstrably influenced fiscal behaviour — as evidenced by the 2011–2015 consolidation response — the design of the rules embodies several structural deficiencies. Nominal debt thresholds are inherently procyclical: their effective tightness varies inversely with nominal GDP growth, which contracts during recessions and expands during booms. The rules lack a structural balance anchor, meaning that they are compatible with the accumulation of structural deficits as long as debt remains below the thresholds during periods of nominal GDP growth. The existing escape clause provisions are inadequately specified in terms of activation criteria, duration, and exit conditions, relative to best international practice — a deficiency confirmed in the comparative legal analysis of constitutional debt limits across European Union member states ^{[17, s. 210]}. The methodological dualism between national and European Union definitions of public debt further reduces transparency and complicates comparison, while potentially enabling creative presentation of the fiscal position ^{[17, s. 192]}.

The recommended fiscal rule architecture for Poland encompasses three complementary elements:

• A structural balance rule anchored to the medium-term budgetary objective specified within the European Union fiscal governance framework, defined in terms of the cyclically adjusted primary balance and adapted to Poland's specific debt trajectory and ageing expenditure profile;
• A differentiated expenditure growth rule limiting the annual growth of primary expenditure to below the trend growth of nominal GDP, with a formal carve-out for productive public investment in physical and human capital, financed within fiscal space compatible with the structural balance anchor;
• A codified escape clause specifying objective activation criteria — severe economic downturns, natural disasters, or systemic financial sector distress — together with a binding sunset provision requiring a return to the structural balance target within a specified medium-term horizon.

The second dimension concerns the reform of medium-term budgetary frameworks. Poland's Multi-Annual Financial Plan of the State (Wieloletni Plan Finansowy Państwa), presented to parliament on an annual basis and covering a four-year rolling horizon, lacks legal bindingness in the sense that annual budget laws are not formally constrained to be consistent with the plan's expenditure projections. This design flaw means that the plan functions principally as an informational document rather than as a binding commitment device. The absence of independent verification of its macroeconomic and fiscal assumptions further reduces its credibility — credibility that is indispensable for the medium-term orientation that sustained fiscal consolidation requires ^{[10, s. 201]}. The structural balance concept itself requires the technically credible and independent estimation of potential output and the output gap, since the distinction between the actual balance and the structural balance is the analytical foundation for growth-neutral fiscal adjustment ^{[14, s. 22]}.

The recommended reforms of the medium-term budgetary framework include the following elements:

• Establishment of legal bindingness for the Wieloletni Plan Finansowy Państwa, such that annual budget proposals deviating from the rolling expenditure ceilings are required to present explicit fiscal offset measures and to obtain parliamentary approval through specified procedural requirements;
• Reconfiguration of the annual budget as the first operational slice of the rolling plan, with automatic carry-forward of expenditure ceilings and mandatory reconciliation of any revisions with the structural balance anchor;
• Introduction of an ex post reconciliation mechanism requiring the government to explain, in the annual fiscal report, the sources and consequences of deviations between actual outturns and plan projections, with the assessment of deviations entrusted to the independent fiscal council;
• Mandatory independent endorsement of the macroeconomic forecasts underpinning the plan as a formal pre-condition for parliamentary consideration of the annual budget proposal.

The third dimension concerns expenditure efficiency and the quality of fiscal reporting. Tax expenditures — comprising exemptions, reduced rates, and preferential treatments within the income tax and value-added tax frameworks — represent a significant source of revenue forgone that is rarely subjected to the same scrutiny as direct expenditure. Estimates associated with the Polish Ministry of Finance medium-term budgetary framework documentation have placed the total value of tax expenditures in the range of 3.5 to 4.5 per cent of GDP in recent years, a substantial implicit fiscal cost that is largely invisible in budget documents because it operates through the revenue side of the general government account. The budget institutions literature emphasises that procedural arrangements that render specific categories of expenditure or revenue forgone less visible to decision-makers and the public are systematically associated with larger deficits ^[15]. The complementary point is that transparent fiscal information and high-quality fiscal reporting are associated with improved access to capital markets and more favourable sovereign borrowing conditions, while accounting opacity amplifies risk premiums ^[12]. The real value of the budget balance — and the distinction between the cyclical balance, which reflects the automatic stabiliser response, and the structural balance influenced by discretionary policy measures — must be communicated accurately and consistently if public accountability for fiscal outcomes is to function effectively ^{[14, s. 3]}.

Specific expenditure efficiency recommendations include:

• The institutionalisation of systematic and comprehensive tax expenditure reviews on a three-year cycle, covering all major tax instruments, with results presented to parliament as a mandatory supplement to the annual budget proposal;
• The introduction of permanent spending reviews as a budgetary instrument, with each review covering a rotating subset of general government expenditure programmes and generating recommendations incorporated into the subsequent medium-term plan;
• A rationalisation of fragmented social transfer programmes exhibiting significant overlap and targeting inefficiencies, maintaining aggregate social protection while improving the distributional precision of transfers relative to their fiscal cost;
• The development of outcome-based performance metrics for major expenditure categories, integrated into the medium-term planning framework to provide a basis for evidence-based expenditure prioritisation.

The fourth and integrative dimension concerns the strengthening of independent fiscal institutions. Poland's Fiscal Council, established in 2017, represents an important institutional development but has demonstrated significant functional limitations relative to best international practice. The Council's mandate in the area of macroeconomic forecast assessment is advisory rather than binding; its analytical capacity is constrained by limited access to microsimulation models and disaggregated fiscal data; and its formal role in European Union fiscal surveillance procedures has not been developed in a manner that maximises the complementarity between domestic and supranational fiscal governance mechanisms. These limitations are not incidental: they reflect the broader pattern identified in the political economy literature whereby fiscal institutions that depend on government goodwill for their analytical inputs and whose assessments carry no formal procedural consequences provide insufficient constraint on discretionary fiscal behaviour.

The theoretical basis for the emphasis on independent fiscal institutions is firmly grounded in the political economy literature. Opportunistic fiscal behaviour — including the systematic tendency of governments to expand expenditure and reduce taxes in pre-electoral periods — and the fiscal illusion associated with the visibility asymmetry between current spending benefits and deferred debt costs, are constrained by credible and independent monitoring and by the public attribution of responsibility for deviations from fiscal commitments ^[15]. The time inconsistency of optimal fiscal policy — the gap between socially optimal commitments and the policies that governments in practice adopt under electoral pressure — is a principal source of the persistent deficit bias observed across economies, and independent fiscal councils with genuine analytical autonomy represent a direct institutional response to this problem ^[13].

In the comparative context, the structural budget institutions developed in Chile demonstrate that institutionalising the distinction between cyclical and structural fiscal positions, by entrusting the estimation of trend output to independent expert panels rather than government ministries, effectively insulates the medium-term fiscal anchor from short-term political pressures and enforces countercyclical fiscal behaviour where procyclical bias has historically prevailed ^[16]. The broader institutionalist observation applies equally: recommending good fiscal policy to a country is insufficient if the political support and institutional architecture necessary to sustain the policy are absent ^[16]. Within the European context, the Irish Fiscal Advisory Council, the Dutch Central Planning Bureau, and the Slovak Council for Budget Responsibility represent models of effective independence combining robust analytical capacity with formal roles in the national budget process that can serve as reference points for a strengthened Polish fiscal council mandate.

The recommended reforms to Poland's fiscal council encompass an enhanced mandate for the endorsement of official macroeconomic forecasts as a prerequisite for their use in the budget process; statutory access to microsimulation models and disaggregated tax and expenditure data held by the Ministry of Finance and the Social Insurance Institution; a formalised role in the preparation of Poland's Stability Programme and in the assessment of compliance with European Union fiscal recommendations; and a reporting requirement ensuring that the Council's assessments are presented to parliament in advance of the vote on the annual budget. The most consequential of these elements is the forecast endorsement function: independent endorsement consistently reduces the optimistic bias in official growth and revenue projections, which is one of the primary mechanisms through which structural deficits accumulate even when governments nominally commit to balanced budget targets.

The synthesis of these four reform dimensions points to a broader conclusion: fiscal sustainability in Poland is not principally a technical problem of calibrating the correct numerical thresholds, but an institutional problem of ensuring that the rules, procedures, and organisations governing fiscal policymaking are sufficiently robust to maintain a credible long-run commitment to sustainability in the face of electoral incentives, coalition bargaining dynamics, and structural expenditure pressures that systematically generate deficit bias. The policy implications of the political economy literature are particularly relevant for institutional reform design — if policy outcomes are influenced by politico-institutional variables, then improvement in fiscal policymaking requires intervention at the institutional level ^[15]. The necessary institutional improvements include legal consistency, transparent accounting, clear definition of the scope of fiscal rules, and stable implementation of European Union fiscal requirements — conditions that require commitment at both the legislative and executive levels ^{[10, s. 201]}. The embedding of these institutional reforms within a growth-friendly fiscal responsibility narrative — one that presents structural fiscal adjustment as the precondition for sustainable public investment in human capital, physical infrastructure, and energy transition rather than an end in itself — constitutes the most politically coherent framework within which the strengthening of Poland's fiscal architecture can be effectively communicated and sustained over successive electoral cycles.

Conclusion

The analysis presented across three chapters establishes, with considerable empirical and theoretical consistency, that Poland's public debt trajectory over the period 1990–2023 reflects not a series of discrete fiscal shocks but the cumulative operation of structural mechanisms that systematically generate deficit bias and translate budgetary imbalances into persistent debt accumulation. The theoretical framework elaborated in Chapter 1 — centred on the arithmetic of debt dynamics, the structural-cyclical distinction, and the institutional conditions governing fiscal credibility — provides the conceptual apparatus through which Poland's historical experience, examined in Chapter 2, and the sustainability challenges assessed in Chapter 3, become analytically intelligible. The long-run dependencies the thesis sets out to investigate are confirmed: deficits have not been temporary deviations from fiscal balance but the expression of structural imbalances embedded in the institutional architecture of public finance, reinforced by electoral incentives and periodically accommodated by one-off accounting measures that postponed rather than resolved the underlying adjustment requirement.

The mechanisms linking deficits to debt identified in Chapter 1 — the interest-growth differential, primary balance dynamics, and the crowding-out of productive expenditure — operate with particular force in Poland's case because structural deficits have been consistently negative across almost the entirety of the sample period. When the interest rate on public debt exceeds the rate of economic growth, even a modest primary deficit generates explosive debt dynamics; and when, as in Poland, the structural primary balance has been negative in all but two years between 2000 and 2023, the stabilising contribution of strong output growth is insufficient to offset the cumulative burden of borrowing costs and persistent imbalances. The Ricardian equivalence proposition — which would imply that private agents anticipate future fiscal correction and offset public deficits through higher saving — receives no empirical support from Poland's trajectory: instead, the politically entrenched commitments to pension expenditure, child benefit transfers, and healthcare outlays have persisted across successive governments irrespective of their ideological orientation, confirming the relevance of the structural deficit concept as a measure of discretionary fiscal stance uncorrected by electoral cycles.

The temporal dimension of the analysis reveals a clear evolution in the character of Poland's fiscal problem over the 1990–2023 period. The deficits of the early transition years — rooted in the collapse of enterprise profit tax revenues, the rapid expansion of unemployment-related social expenditure, and the residual practice of monetary financing — were qualitatively distinct from the structural imbalances that emerged in the mature phase of fiscal reform. The 1999 pension reform introduced a structural fiscal deficit of 1.5–2.0 percentage points of GDP annually, as the funded pillar accumulated assets outside the general government sector while contributions were diverted from the pay-as-you-go system. Poland's accession to the European Union in 2004 and the consequent submission to the Stability and Growth Pact framework provided an external anchor that moderated but did not eliminate the domestic tendency toward deficit expansion. The financial crisis of 2008–2009, the subsequent Excessive Deficit Procedure, and the consolidation episode of 2010–2015 demonstrated that adjustment was politically feasible but relied disproportionately on revenue measures and the 2014 OFE asset transfer — a one-off measure that improved the measured debt ratio without correcting the structural primary balance. By 2023, Poland entered a period of renewed fiscal expansion with defence and social commitments expanding simultaneously, and with the demographic deterioration projected to intensify through 2060, the inherited pattern of structural deficit had become more, not less, entrenched relative to the early 2000s.

The institutional weaknesses contributing to structural deficit persistence are identified as the central analytical finding of the thesis. Three dimensions of institutional failure are particularly evident. First, the absence of a binding structural balance rule has allowed successive governments to present cyclically inflated revenue outturns as evidence of fiscal rectitude while embedding expenditure commitments that prove durable beyond the expansion phase. The constitutional 60 percent debt-to-GDP ceiling and the 50 and 55 percent prudential thresholds have functioned primarily as crisis-avoidance mechanisms activated only at moments of acute fiscal stress, not as ongoing constraints on annual fiscal stance. Second, the optimistic bias in official macroeconomic projections — documented across Poland, Czech Republic, Hungary, and Slovakia in the comparative analysis — has systematically underestimated the structural deficit, reducing the credibility of medium-term fiscal frameworks and generating recurrent gaps between budgeted and outturn positions. Third, the institutional mandate and operational capacity of the Polish Fiscal Council have been insufficient to provide the independent verification of fiscal forecasts and sustainability assessments that would reduce the informational asymmetry between government and the public regarding the true state of public finances. These three institutional gaps — absent structural rule, biased forecasting, and weak fiscal council — constitute a mutually reinforcing system in which each element perpetuates the others.

The sustainability assessment conducted in Chapter 3 confirms that the long-run fiscal challenge facing Poland is driven primarily by the cost-of-ageing component rather than by current debt service obligations, though the interaction between the two renders the sustainability gap considerably more severe than either would imply in isolation. The old-age dependency ratio is projected to rise from approximately 31 in 2023 to over 60 by 2060, generating automatic expenditure pressures in pension and healthcare systems that, under current policy parameters, would widen the structural deficit even if near-term imbalances were corrected. The European Commission's S2 sustainability indicator — estimated at 4.0–4.5 percentage points of GDP — establishes the scale of the permanent primary balance adjustment required to place the debt trajectory on a non-explosive path over an infinite horizon. This magnitude exceeds what can be delivered through expenditure restraint alone and implies a combination of structural revenue measures, entitlement reform, and institutional strengthening of the medium-term fiscal framework that would require sustained political commitment across multiple electoral cycles.

The policy implications that emerge from the integrated analysis point consistently toward institutional reform as the precondition for credible fiscal adjustment. The calibration of optimal numerical targets — whether for the deficit, the debt ratio, or the structural primary balance — is of secondary importance if the institutional environment does not generate sufficient commitment technology to render announced consolidation paths credible to financial markets, the European Commission, and the domestic public. A structural balance rule with transparent escape clause provisions, a legally binding medium-term expenditure framework, systematic review of the tax expenditure system, and a strengthened fiscal council with statutory access to macroeconomic models and a formalised role in EU fiscal surveillance collectively constitute the institutional architecture capable of sustaining the adjustment over the horizon required by the ageing demographic profile. Without these institutional foundations, numerical targets remain aspirational commitments subject to discretionary revision whenever electoral incentives or coalition bargaining create pressures for relaxation.

The evidence examined in this thesis confirms that the relationship between budget deficits and public debt in Poland is not episodic but structural, not accidental but institutionally generated, and not self-correcting in the absence of deliberate reform of the rules and organisations governing fiscal policymaking. The long-run dependencies demonstrated across the 1990–2023 period will intensify in the coming decades as demographic pressures compound the existing structural imbalances unless institutional reform creates credible commitment to fiscal responsibility. The principal challenge for Polish fiscal policy is therefore not to identify the correct numerical adjustment target but to construct the institutional environment in which such targets bind in practice rather than in statute. The conditions for successful consolidation — political consensus around the distributional implications of adjustment, independent oversight capable of exposing optimistic projections, and a growth-friendly fiscal framework presenting structural balance as the foundation for sustainable public investment — are demanding but not unprecedented. The experience of peer economies that have achieved durable fiscal consolidation demonstrates that the arithmetic of debt dynamics, while inexorable, can be turned from a source of compounding vulnerability into the basis for renewed fiscal space, provided that the institutional preconditions are met with sufficient resolve and consistency.

List of Tables

1. Table 1.1. Principal Classifications of Public Debt
2. Table 1.2. Fiscal Thresholds and Corrective Mechanisms in Poland
3. Table 2.1. Poland's General Government Balance and Gross Debt (% of GDP), Selected Years 1990–2023
4. Table 2.2. Comparative Fiscal Indicators: Poland, Czech Republic, Hungary, and Slovakia
5. Table 3.1. Fiscal Sustainability Indicators S1 and S2 for Selected Central and Eastern European Countries (Illustrative Estimates Based on European Commission Methodology, Reference Year 2023)
6. Table 3.2. Illustrative General Government Debt Projections for Poland Under Three Scenarios, 2023–2035 (per cent of GDP)

Annex

Appendix 1. Variable Operationalization Card

Table A.1. Operationalization of Variables Used in the Empirical Analysis

Variable Name	Symbol	Definition	Unit	Data Source	Eurostat / AMECO Code	Expected Sign in Bohn Reaction Function
General government balance	bt	Net lending (+) or net borrowing (–) of the general government sector (S.13) as defined under ESA 2010, expressed as a share of gross domestic product at current market prices. A negative value indicates a fiscal deficit; a positive value indicates a surplus.	% of GDP	Eurostat Government Finance Statistics (GFS)	gov_10dd_edpt1, variable: B9 / GDP	Dependent variable (primary surplus variant: positive response to lagged debt expected)
General government consolidated gross debt	dt	Outstanding stock of gross consolidated liabilities of the general government sector at nominal (face) value, encompassing currency and deposits, debt securities, and loans as defined in ESA 2010 Chapter 7. Intra-government claims are consolidated out. Expressed as a share of GDP at current market prices.	% of GDP	Eurostat Government Finance Statistics (GFS)	gov_10dd_edpt1, variable: GD / GDP	Positive (key regressor; coefficient 0.05–0.08 expected for fiscal sustainability)
Real GDP growth rate	gt	Annual percentage change in gross domestic product at constant (chain-linked) prices, base year 2015. Captures the cyclical position of the economy and serves as a control variable in both the VECM and the Bohn reaction function, reflecting the automatic stabiliser channel.	% per annum	Eurostat National Accounts; AMECO macroeconomic database	nama_10_gdp (CLV15_MEUR, annual growth); AMECO: OVGD	Negative (higher growth reduces debt ratio mechanically; expected to reduce primary surplus requirement)
General government interest expenditure	rt	Actual interest payments (ESA 2010 code D.41) accruing on outstanding general government debt liabilities in a given fiscal year, expressed as a share of GDP at current market prices. Used to construct the primary balance from the overall balance and as a proxy for the effective implicit interest rate on public debt.	% of GDP	Eurostat Government Finance Statistics (GFS)	gov_10a_exp, variable: D41 / GDP	Positive (higher interest burden is associated with larger required primary surplus)
Output gap	ytgap	Deviation of actual real GDP from estimated potential real GDP, expressed as a percentage of potential GDP. Potential GDP is estimated by the European Commission using a production function methodology. A positive gap indicates an overheated economy; a negative gap indicates recessionary conditions. Used in the Bohn reaction function as a proxy for cyclically driven expenditure and revenue variations.	% of potential GDP	European Commission AMECO database; European Commission Spring Forecast	AMECO: AVGDGP (output gap, % potential GDP)	Negative (a positive output gap is associated with cyclically improved fiscal balance, reducing the need for discretionary fiscal adjustment)

Note: All variables are measured at annual frequency. GDP denominator is gross domestic product at current market prices (ESA 2010 code B1GQ) sourced consistently from Eurostat National Accounts to ensure comparability of ratios across countries and time.

Appendix 2. Panel Dataset: Countries and Years

Table A.2. Country Coverage and Temporal Scope of the Panel Dataset

Country	ISO 3166-1 Alpha-2 Code	Currency	Period Covered — Primary Analysis	Period Covered — Comparative Panel Analysis	Notes
Poland	PL	Polish zloty (PLN)	1995–2023 (29 annual observations)	2000–2023 (24 annual observations)	2014 OFE asset transfer creates a structural discontinuity of approximately 8 percentage points of GDP in the gross debt series (see Appendix 3). Analytical series adjusted for this one-off effect are used in robustness checks for the 2014–2016 sub-period. EU member since 2004; ERM II not entered as of 2023.
Czech Republic	CZ	Czech koruna (CZK)	—	2000–2023 (24 annual observations)	EU member since 2004. Has not adopted the euro as of 2023. Shares broadly similar institutional and fiscal framework with Poland within the Visegrad Group context.
Hungary	HU	Hungarian forint (HUF)	—	2000–2023 (24 annual observations)	EU member since 2004. Has not adopted the euro as of 2023. A comparable pension fund asset transfer (2011) affects the gross debt series; the Eurostat ESA 2010 revised series is used throughout to ensure cross-country consistency.
Slovakia	SK	Euro (EUR) from 2009; Slovak koruna (SKK) prior	—	2000–2023 (24 annual observations)	EU member since 2004. Adopted the euro on 1 January 2009 (ERM II entry: 28 November 2005). The currency change does not affect fiscal ratios expressed as shares of GDP. The exchange rate used for pre-2009 debt conversion follows the irrevocable fixing rate (30.1260 SKK/EUR).

The primary analysis (Poland only, 1995–2023) yields 29 country-year observations, which represents the full unbalanced series available under ESA 2010 consistent definitions from Eurostat. The comparative panel analysis yields 96 country-year observations (4 countries × 24 years, 2000–2023), constituting a balanced panel. The comparative panel start date of 2000 is imposed by data availability constraints for all four countries simultaneously under harmonised ESA 2010 definitions.

Appendix 3. Data Collection and Coding Protocol

A.3.1. Database Access and Extraction Procedure

All primary data were extracted from two official institutional sources: the Eurostat Statistics Database (accessible at ec.europa.eu/eurostat/data/database) and the Annual Macro-Economic Database of the European Commission (AMECO, accessible at economy.ec.europa.eu/economic-research-and-databases/economic-databases/ameco-database). The extraction was conducted systematically during the first quarter of 2024, using the final revised vintages available at that date. No preliminary or provisional estimates were used where revised data existed. Data were downloaded in CSV format and imported into the statistical software environment without intermediate transformation, to preserve source precision.

The following procedural steps were applied uniformly across all variables and countries:

• Each Eurostat dataset was accessed via the dedicated table identifier (see Appendix 1 for codes). Filters were set for: sector = S.13 (general government); national accounts indicator = relevant ESA 2010 code; unit = percentage of GDP at current market prices; frequency = annual; geographic area = PL, CZ, HU, SK; time period = 1995–2023 (or 2000–2023 for the comparative panel).
• AMECO variables (output gap, AVGDGP) were extracted from the Spring 2024 forecast vintage, which constitutes the most recent stable published series at the time of analysis. The output gap series incorporates the Commission's production function methodology, which accounts for trend total factor productivity, capital accumulation, and the non-accelerating wage rate of unemployment (NAWRU).
• All downloaded series were validated against the corresponding values published in the European Commission's Fiscal Sustainability Report 2023 and the Debt Sustainability Analysis for Poland (2023) to identify and flag any discrepancies arising from subsequent data revisions.

A.3.2. Sector Definition and Consolidation Standard

The general government sector is defined in accordance with the European System of Accounts (ESA 2010), Regulation (EU) No 549/2013 of the European Parliament and of the Council. Sector S.13 encompasses four sub-sectors: central government (S.1311), state government (S.1312), local government (S.1313), and social security funds (S.1314). All fiscal aggregates — net lending/borrowing, interest expenditure, and gross debt — are reported on a consolidated basis, meaning that financial flows and stock positions between units within the general government sector are eliminated. This consolidation procedure is applied by Eurostat before publication; no additional consolidation adjustments were performed by the author.

A.3.3. Treatment of the 2014 OFE Asset Transfer

In February 2014, the Polish government transferred a portion of assets held in the Open Pension Funds (Otwarte Fundusze Emerytalne, OFE) — predominantly government bonds — to the Social Insurance Institution (ZUS), a unit classified within sector S.13. Under ESA 2010 accounting rules, the bonds transferred from OFE (classified outside S.13) to ZUS (classified within S.13) were simultaneously cancelled as liabilities of the Treasury. This one-off statistical operation reduced Poland's general government consolidated gross debt by approximately 8 percentage points of GDP in 2014, creating a structural discontinuity in the time series.

The following protocol was applied to address this discontinuity:

• For the baseline regressions covering the full 1995–2023 period, the official Eurostat ESA 2010 series is used without modification, as it represents the legally and statistically authoritative definition of general government debt consistent across all EU member states.
• For robustness checks specific to the 2014–2016 sub-period, an adjusted analytical series is constructed by adding back the estimated value of the transferred bonds (8 pp of GDP, applied as a constant adjustment to the official series) to assess whether the cointegrating relationship and VECM speed-of-adjustment coefficient are sensitive to this event. The adjusted series is labelled explicitly as such in all tables and figures.
• A structural break dummy variable (taking the value 1 in 2014, 0 otherwise) is included in the Johansen cointegration specification and the VECM as a deterministic impulse indicator to prevent the discontinuity from contaminating the cointegrating vector estimates.

A.3.4. Output Gap Estimation

The output gap variable is taken directly from the European Commission's Spring Forecast AMECO database (variable AVGDGP: output gap as a percentage of potential GDP, general government). The Commission employs a production function approach to estimate potential output, decomposing GDP into contributions from labour, capital, and total factor productivity. Trend total factor productivity is estimated using a Kalman filter, and the NAWRU is estimated using a bivariate structural model. This methodology is common to all EU member states, ensuring cross-country comparability within the Visegrad panel. No alternative output gap measures (e.g. Hodrick-Prescott filtered series) are used in the primary specifications, to avoid the well-documented endpoint bias and revision sensitivity of filter-based approaches; however, an HP-filtered output gap (smoothing parameter λ = 100, as recommended for annual data) is employed as a robustness check in alternative Bohn reaction function estimates.

A.3.5. Lag Selection Procedure for Unit Root Tests

The number of augmenting lags in the Augmented Dickey-Fuller (ADF) test specification was selected for each series individually using the Schwarz Information Criterion (SIC, also referred to as the Bayesian Information Criterion), evaluated over a maximum lag length of p_max = floor(12 × (T/100)^1/4), where T denotes the number of usable observations. For the primary Poland series with T = 29, this yields p_max = 5. The lag length minimising the SIC was selected within this range. The same procedure was applied for both the level and the first-difference specifications, and independently for the Phillips-Perron test bandwidth selection (using the Newey-West automatic bandwidth selector with a Bartlett kernel). ADF test results for alternative lag lengths (±1 lag from the SIC-selected value) are reported as a sensitivity check to confirm robustness of the unit root classification.

A.3.6. Definition of Temporary Expenditure Shocks in the Bohn Framework

The Bohn (1998) fiscal reaction function includes a control variable for temporary government expenditure to avoid attributing cyclically or shock-driven fiscal deterioration to discretionary debt-stabilising behaviour. Two episodes are identified as generating temporary expenditure shocks in the estimation period:

• COVID-19 pandemic transfers, 2020–2021: Extraordinary public expenditure comprising direct income support transfers, short-time work scheme subsidies, healthcare emergency spending, and loan guarantees extended to the private sector, as classified in the Polish Anti-Crisis Shields (Tarcze Antykryzysowe). These are measured as the deviation of general government transfers and subsidies (ESA 2010 codes D.6 + D.7) from their 2015–2019 trend in each year. The shock dummy takes the value of this deviation (expressed in percentage points of GDP) in 2020 and 2021, and zero otherwise.
• Defence expenditure spike, 2022–2023: A marked increase in general government defence expenditure (COFOG division 02) following Russia's full-scale invasion of Ukraine, driven by procurement commitments and NATO commitments to reach 4% of GDP in defence spending.^{[21, s. 7]} The temporary shock component is measured as the deviation of defence spending from its 2015–2021 trend, expressed in percentage points of GDP. This component is included separately from the COVID shock dummy to preserve the distinctness of the two episodes and to allow their coefficients to be estimated independently in robustness specifications.

Appendix 4. Econometric Specification Summary

A.4.1. Unit Root Test Specification (Augmented Dickey-Fuller)

The stationarity properties of each variable are assessed using the Augmented Dickey-Fuller test.^{[22, s. 104]} The test equation for the level of variable x_t is specified as:

Delta x_t = alpha + beta × t + gamma × x_t-1 + sum(delta_i × Delta x_t-i, i=1 to p) + epsilon_t

where Delta denotes the first-difference operator, alpha is a constant, beta × t is an optional linear trend term, gamma is the parameter of interest (the null hypothesis of a unit root corresponds to gamma = 0 against the alternative gamma < 0), p is the number of augmenting lags selected by the Schwarz Information Criterion as described in Appendix 3.5, and epsilon_t is a white noise disturbance. Three model variants are estimated for each series: (i) no constant, no trend; (ii) constant only; (iii) constant and linear trend.^{[23, s. 3616]} The appropriate specification is selected on the basis of the visual inspection of the series and on the sequential testing procedure of Dolado, Jenkinson, and Sosvilla-Rivero (1990). Critical values are taken from MacKinnon (1996). The Phillips-Perron test is applied as a nonparametric complement to the ADF, with the same three deterministic specifications and the Newey-West long-run variance estimator.^{[24, s. 14]} Both tests are applied in levels and in first differences; a series is classified as integrated of order one — I(1) — when the null of a unit root cannot be rejected in levels but is rejected in first differences at the 5 per cent significance level.

A.4.2. Johansen Cointegration and VECM Specification

The long-run relationship between the general government balance and the gross debt ratio is examined within a Vector Error Correction Model (VECM) framework using the Johansen (1988, 1991) maximum likelihood approach. The bivariate system in levels is written as:

Y_t = [b_t, d_t]'

where b_t is the general government balance (% GDP) and d_t is the gross debt ratio (% GDP). The corresponding VECM in first differences is:

Delta Y_t = alpha × beta' × Y_t-1 + sum(Gamma_i × Delta Y_t-i, i=1 to k-1) + Psi × Z_t + mu + epsilon_t

where alpha is a (2×r) matrix of speed-of-adjustment coefficients, beta is a (2×r) matrix of cointegrating vectors, r denotes the cointegration rank (tested as r=0 and r=1 against the unrestricted alternative), Gamma_i are short-run coefficient matrices, Z_t is a vector of weakly exogenous conditioning variables (real GDP growth rate), mu is a vector of deterministic terms, and epsilon_t is a vector of Gaussian disturbances. The deterministic specification includes a restricted constant (entering the cointegrating space) and an unrestricted impulse dummy for 2014 (OFE transfer, as described in Appendix 3.3). The lag order of the VAR in levels is set to k, selected by the SIC over a maximum of five lags; the VECM therefore includes k-1 lagged difference terms. The rank r is determined by the trace test and the maximum eigenvalue test at the 5 per cent level using Osterwald-Lenum (1992) critical values. One cointegrating vector is identified. The normalised cointegrating vector is restricted such that the coefficient on the debt ratio is unity, allowing direct interpretation of the fiscal balance coefficient as the long-run impact of a one-percentage-point change in the deficit on the equilibrium debt level. Real GDP growth is treated as weakly exogenous following a block-exogeneity test on the alpha matrix row corresponding to g_t.

A.4.3. Bohn Reaction Function Specification

Fiscal sustainability is assessed using the reaction function approach of Bohn (1998). The primary surplus (cyclically adjusted) is regressed on its own determinants, with the key parameter of interest being the response of the primary balance to the lagged gross debt ratio. The OLS specification is:

ps_t = c + phi × d_t-1 + kappa₁ × y_t^gap + kappa₂ × GVAR_t^COVID + kappa₃ × GVAR_t^DEF + u_t

where ps_t is the primary surplus (general government balance excluding interest expenditure, % GDP), d_t-1 is the lagged gross debt ratio (% GDP), y_t^gap is the output gap (% potential GDP), GVAR_t^COVID is the COVID-19 temporary expenditure shock variable (2020–2021), GVAR_t^DEF is the defence expenditure shock variable (2022–2023), c is a constant, phi is the fiscal sustainability coefficient (expected positive and statistically significant for a sustainable fiscal path), and u_t is the disturbance term. The primary surplus is constructed as: ps_t = b_t + r_t, where b_t is the overall balance and r_t is interest expenditure. The coefficient phi is interpreted following Bohn (1998): a strictly positive and statistically significant estimate is sufficient for fiscal sustainability under very general assumptions about the discount rate, irrespective of the level or trajectory of the debt ratio. Estimation is by Ordinary Least Squares with Newey-West heteroscedasticity-and-autocorrelation-consistent (HAC) standard errors, bandwidth selected automatically. The sample used is 1997–2023 (two observations are lost to the lag structure). Robustness specifications add: (i) two lags of the primary surplus to control for fiscal inertia; (ii) the HP-filtered output gap as an alternative cyclical control; (iii) the comparative Visegrad panel estimated with country fixed effects and clustered standard errors at the country level.

A.4.4. Diagnostic Tests

The following diagnostic procedures are applied to assess the validity of the regression assumptions and the temporal stability of the estimated relationships:

• Residual autocorrelation: The Breusch-Godfrey Lagrange Multiplier test is applied to the OLS residuals of the Bohn reaction function up to lag order four, and to the VECM residuals using the portmanteau (Ljung-Box) statistic. The null hypothesis of no serial correlation is tested at the 5 per cent level. The absence of residual autocorrelation confirms the adequacy of the lag structure.
• Heteroscedasticity: The White test (with cross-product terms) is applied to the Bohn reaction function residuals to test for conditional heteroscedasticity.^{[25, s. 203]} The null hypothesis of homoscedasticity is tested at the 5 per cent level. Given the short sample, non-rejection of the null is expected; HAC standard errors are reported regardless to provide robustness against mild heteroscedasticity.
• Parameter stability: The CUSUM (Cumulative Sum of Recursive Residuals) and CUSUM-of-Squares tests are applied to assess whether the regression coefficients remain stable over the estimation period. Test statistics are plotted against 5 per cent significance bounds. Both tests indicate episodes of instability associated with the 2009–2010 global financial crisis and its fiscal aftermath, and with the 2020–2021 COVID-19 shock. These episodes do not invalidate the long-run estimates but motivate the inclusion of the temporary expenditure shock controls in the Bohn specification and the structural break dummy in the Johansen system.
• Cointegration rank robustness: The sensitivity of the Johansen rank determination to the lag order is assessed by re-estimating the trace and maximum eigenvalue statistics for lag orders k-1 and k+1 relative to the SIC-selected baseline. The cointegrating rank r = 1 is confirmed across all three lag specifications.
• Normality of residuals: The Jarque-Bera test is applied to the residuals of the Bohn OLS specification. Non-normality associated with the 2020 observation (COVID shock) is noted; this does not affect consistency of OLS estimates but reinforces the motivation for HAC inference.