Public Debt May Rise To Unsustainable Levels

The term “too big to fail” has led to several bailouts and to an unprecedented increase in public debt. Indeed, the gross public debt of the ten richest countries in the world will grow by $9 trillion in the next three years reaching 106% of GDP, up from 78% in 2007, according to International Monetary Fund. More importantly, although there is little danger that countries will default on its bonds, it will take generations to pay for all this debt.

Government debt is sustainable if GDP growth is bigger than the average interest payments on past debt.  However, looking at the scale of the current economic slowdown it will be very difficult to achieve that balance in the next few years. For example, the World Bank projects that United States GDP will contract 3% this year while some U.S. treasuries were sold recently with 4% yield. Looking further, it is likely than within next few years, budget deficits will get even bigger as over-indebted consumers focus on rebuilding their savings and tax revenues deteriorate further.

So what should governments do to clean up their public finances? Many governments have been responding to the current economic slowdown by spending more in order to boost investments, consumption and employment. However, the solution to the economic crisis is not so simple or easy. At Trading Economics we think governments will be forced to cut spending, raise taxes and increase the retirement age.

Anna Fedec,
6/24/2009 4:58:33 PM