Government debt – beware of financial repression

Sustainability of Government Debt at Risk

Bond yields have risen sharply this year. For example, the yield on the 10-year U.S. Treasury notes has risen by a good 100 basis points since the start of the year to 5.25%. The yield on comparable French bonds has risen by more than 130 basis points to 4.92%, with the increase having accelerated significantly over the past days.

The markets do not only worry about inflation, but also about the sustainability of government finances. The U.S. federal government has accumulated debt amounting to more than 100% of GDP (see chart). The U.S. debt-to-GDP ratio is thus already as high as it was at the end of World War II. Among the major countries in the eurozone, Italy’s debt-to-GDP ratio is more than double the maximum allowed by the Maastricht Treaty. France, with its excessive budget deficit of more than 5% of GDP, could be similarly indebted in ten years.

To prevent a further rise in the public debt-to-GDP ratio and thus allay concerns about the sustainability of public debt, France would, according to our calculations, need to reduce its budget deficit by an amount equivalent to a good 5% of GDP (Chart 1). However, due to the rise of left- and right-wing populists, the government lacks a stable majority to carry out the necessary fiscal consolidation. In other eurozone countries, too, the shrinking of the political center is hindering sustainable fiscal policy. In the U.S., Congress is not as fragmented due to the two-party system. However, as both parties become more radicalized, the focus on the common good is fading. A sitting president is less willing to pursue fiscal consolidation, since it is ultimately his successor – who might even be from the opposing party – who stands to benefit most from such measures. All in all, there is strong evidence to suggest that the already high public debt-to-GDP ratios of Western countries will continue to rise in the coming years – and with them, the financing problems faced by these nations.

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