Abstract: In this study, we examine the connection between fiscal policy and banking activity. Over recent decades, the budget balance, a key fiscal indicator, has faced deterioration, prompting concerns about the factors influencing its fluctuations. We investigate this relationship by analyzing fiscal and monetary variables, including public debt, inflation, foreign direct investments, remittances, and bank credit, across 34 OECD countries from 2005 to 2020. Employing a Panel Smooth Transition Regression (PSTR) model, our findings reveal that the budget deficit responds to banking profitability, measured by Return on Assets, and a country's banking system's probability of default (Z-Score). The impact varies based on the preceding year's public debt level, with higher sensitivity observed in heavily indebted countries.

Keywords: Budget Deficit, Public Debt, COVID-19, Smooth Transition, OECD countries

JEL codes: C58; H30

DOI: ...