The last review of the ECB's monetary policy strategy in 2003 followed a period of predominantly upside risks to price stability. Experience following the 2008 financial crisis has focused renewed attention on the question of how monetary and fiscal policy should best interact, in particular in an environment of structurally low interest rates and persistent downside risks to price stability. This debate has been further intensified by the economic impact of the coronavirus (COVID-19) pandemic. In the euro area, the unique architecture of a monetary union consisting of sovereign Member States, with cross-country heterogeneities and weaknesses in its overall construction, poses important challenges.12 Tax policy may also substitute interest rate policy to change real interest rates (the cost of current consumption in terms of future consumption), even in the case of balanced budgets. See Feldstein (2002) and Correia et al. (2013).

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The interest rate-growth differential (𝑖𝑖 − 𝑔𝑔) is an important determinant of government debt dynamics and sovereign sustainability analysis. A persistently negative differential could in principle enable lowering debt ratios even in the absence of primary surpluses. Many advanced economies, including in the euro area, had recently -before the COVID 19-crisis hit -exhibited a strong negative inertia in their 𝑖𝑖 − 𝑔𝑔. But to which extent can this be sustained? The focus of our analysis is on the mature euro area economies over the EMU period and the decades before, when the differential was mostly positive on average. We use panel econometric techniques to identify the determinants of 𝑖𝑖 − 𝑔𝑔 across euro area countries and then employ a panel BVAR model to forecast 𝑖𝑖 − 𝑔𝑔, while providing various sensitivity analyses. We conclude that the differential is likely to remain negative after the COVID 19-crisis and well below its long-term average for most euro area countries, but several factors will likely push it up. This would warrant caution in the conduct of fiscal policy over the medium term for the high debt countries, where 𝑖𝑖 − 𝑔𝑔 is higher on average and the probability of positive values over the medium term is non-negligible. Finally, the on-going crisis, whose duration and economic effects are hard to predict, brings an unprecedented level of uncertainty for both the short and long-run dynamics of the differential.