Thus, long-term real interest rates might remain high persistently, partly because of perceptions of inflation risk, partly because of quantitative tightening and partly because the fiscal deficits of many countries are expected to remain large. All this threatens to create a vicious circle in which high perceptions of risk raise interest rates above likely growth rates, thereby making fiscal positions less sustainable and keeping risk premia high. Elevated fiscal debt also worsens the threat of a “bank-sovereign nexus”, in which weak banks cause concern about the ability of sovereigns to rescue them and vice versa.
Arguably, the situation of the US is the most significant of all. In The Budget and Economic Outlook: 2024 to 2034, the non-partisan Congressional Budget Office notes that “debt held by the public rises each year in relation to the size of the economy, reaching 116 per cent of GDP in 2034 — an amount greater than at any point in the nation’s history. From 2024 to 2034, increases in mandatory spending and interest costs outpace declines in discretionary spending and growth in revenues and the economy, driving up debt. That trend persists, pushing federal debt to 172 per cent of GDP in 2054.”
Only a brave economist could insist that this can continue forever. At some point, surely, Stein’s law would bite: investor resistance to further rises in debt would jump and then monetisation, inflation, financial repression and a global monetary mess would ensue.
Here are three relevant facts for the US: first, by 2034, mandatory federal spending is forecast to reach 15.1 per cent of GDP against total federal revenue of a mere 17.9 per cent; second, federal revenue was just 73 per cent of outlays in 2023; and, third, the primary balance has been in consistent deficit since the early 2000s. All this shows how immensely difficult it will be to bring overall deficits under control.