The financial crisis has taken a heavy toll on government finances as the authorities stepped in to bail out institutions and support their economies. At a macro level the surge in private debt up to the crisis has largely been replaced by public borrowing on nations’ balance sheets.
Recent estimates from the IMF put the collective budget deficit for the G-20 advanced economies at 7½% of GDP in 2011 with the US, UK and Japan all running at around 10%. For the G-20 outstanding government debt was estimated to have been close to 110% of GDP last year and rising. This compares with less than 80% in 2006, and around 60% in many economies.
In this Talking Point we look at the action required to return government finances to a pre-crisis level and the challenges this poses to growth. We also ask who faces the greatest challenge and whether markets reflect this.
- Returning to pre-crisis public debt levels looks hopelessly unrealistic given the turnaround required to stabilise debt ratios, let along bring them down. Taking into account the current level of debt, the structural budgets currently in place and the increasing burden placed on public finances by demographic trends, developed nations such as the US, Japan, UK and Eurozone members require significant consolidation measures to improve the public finances.
- The task of bringing debt levels down is made more difficult by the number of countries who need to tighten policy simultaneously. The effects of co-ordinated fiscal consolidation by countries generating the majority of global GDP is likely to place a limit on world growth, absent a major technological innovation or policy transformation in the emerging world. The problem is made worse in the current environment by the inability of monetary policy to stimulate demand and provide an offset to the fiscal headwind.
- Our cross country analysis of who faces the greatest challenge does not seem to be reflected in the pricing of default by the market. The accepted explanation for this is that markets are discriminating on the basis of countries which can print their own currency (Quantitative Easing). The danger though is that this leads to inflation - a risk that investors seem to be ignoring in overlooking the scale of the fiscal challenges faced by the major economies.