The global public debt levels are historically high in almost all economies following the shocks of the pandemic and the war in Ukraine. Projections until the end of the decade are not optimistic, with debt-to-GDP ratios expected to increase to 127% in advanced economies and 80% in emerging economies by 2029. The growth of income associated with the inflation outbreak of 2021-23 is expected to decline, adding to the challenges. The sustainability of public debt in the medium term is called into question without a substantial and sustained increase in productivity in the face of rapid technological change.
The complex geopolitical landscape, higher defense spending, possibly higher interest rates and inflation, and the challenges posed by an aging population and high public spending in advanced economies are causing concern among academics, central banks, international organizations, and investors. The article explores the risks presented by this situation and possible solutions, none of which are easy and all come with costs.
Interest rates play a crucial role in determining the cost of debt, and their evolution relative to income growth is key to debt dynamics. Historic low interest rates between 2014 and 2021 allowed governments to finance deficits and refinance debt relatively easily. However, these favorable conditions are waning, with higher equilibrium interest rates, increased public expenditure needs, and a transition to renewable energy adding pressure on the cost of debt financing.
There is a risk of higher and more volatile fiscal risk premiums in interest rate curves, affecting debt financing costs. The changing structure of debt holders, with a shift towards private investors and away from foreign official investors, is already noticeable. Economic factors such as limited cooperation, sanctions, and increasing trade and financial fragmentation are pushing emerging economies to seek alternative investment solutions for their excess savings.
The relationship between monetary and economic policies is crucial, especially given the need for central bank and government cooperation to ensure fiscal sustainability. Consensus suggests that governments must take decisive action, including gradual fiscal adjustments, structural reforms to contain healthcare and pension spending pressures, greater fiscal transparency, and policies that promote innovation and productivity growth.
Governments must make difficult decisions to balance the defense of the welfare state with the necessary investments and spending requirements demanded by the current and future economic environment. Inaction could lead to a loss of investor confidence, prompting more severe decisions in the future. Temporary solutions and patches could further erode the stability of public debt as a store of value, limiting non-radical solutions that democracies may not be prepared for. José Manuel Amor provides insight into the economic challenges and calls for proactive decision-making to address the growing debt crisis.
