Brunetti View November 2024
published: 05 November 2024
National debt moves into the spotlight
Little has changed in the overall economic situation since the last assessment six months ago. The industrial sector is still in a prolonged slump in most of the countries relevant to Switzerland, but services are developing dynamically — well enough to prevent recessions in most cases. Germany is still the most troubled of the major European countries, with recessionary trends that have now lasted for quite a long time. The general outlook has not changed significantly either. In its latest forecast from mid-October, the International Monetary Fund (IMF) expects moderate growth of the global economy in the current and coming year. The obvious discrepancy between sluggish economic development and booming labour markets remains remarkable. On a positive note, inflation has continued to fall in most countries and inflation rates are falling into areas where it is possible to call it price stability. The growth forecasts for Switzerland in 2025 are slightly higher than for the Eurozone, but still remain below the long-term average.
The economic development in the US raises a few question marks in my assessment. At first glance, it looks comparatively positive. This year and next year, growth is likely to be significantly higher than in the major European countries. The inflation rate has also fallen significantly from a very high level. However, if you take a closer look, the situation is somewhat less bright. In contrast to most other countries, the growth momentum is weakening in 2025 compared to 2024 according to the forecasts. Although core inflation (inflation of all goods without the particularly volatile categories of energy and food) has fallen, it remains well above 3%. This does not suggest that the inflation momentum has already been sustainably broken. Above all, it is important to bear in mind when assessing the US that fiscal policy has been massively more expansive in recent years than in the past as well as in comparable countries. This has probably dampened economic development to such an extent that the comparatively favourable growth rates need to be put into perspective. In addition, this has led and continues to lead to a long-lasting over-stimulation of the economy, which is probably the main reason for the continuing high inflation dynamics. Above all, however, the ongoing fiscal stimulus is creating massive budget deficits and thus ongoing new debt in the US. And — if the statements made by both candidates for the presidency are to be taken seriously — this unsustainable fiscal policy is likely to continue in the coming years. By that point at the latest, the issue of national debt is likely to be at the forefront of global economic risks. We therefore want to take a closer look at the situation.
Global national debt on the rise
Although the US is a particularly drastic case in terms of debt dynamics, it is by no means an exception. Worldwide public debt has risen disproportionately since the Great Financial Crisis. This is illustrated in the chart.
It shows the development of national debt ratios for a selection of important industrialised countries over the last 30 years and the IMF’s forecasts. The effects of the two global economic crises are clearly visible. While debt ratios remained relatively constant until 2008, they began to rise sharply during the Great Financial Crisis. The momentum then eased somewhat before the great pandemic in 2020 caused another jump upwards and pushed the ratios to new record highs. Two countries stand out: On the one hand, Italy, which, in contrast to the other countries analysed, already had a debt ratio of well over 100% at the beginning of the period in 1995. Italy’s debt problems clearly did not arise in the last 30 years, but in the decades before. On the other hand, of course, there is Switzerland. At the beginning of the period under review, our country had a debt ratio that was roughly at the same level as in the countries analysed. From 2005 onwards, however, the dynamics changed completely. In the last approximately 20 years, Switzerland’s debt ratio has been declining.
The financial crisis is not reflected at all in its course and the pandemic only led to a slight increase, which was significantly less pronounced than in other countries. Today, Switzerland’s debt ratio is significantly lower than that of comparable countries. The main reason for this favourable development was the introduction of the ‘debt brake’, which forces our country to maintain a balanced budget throughout economic cycles. As this stabilises debt and GDP continues to grow, the trend in the debt ratio, which we can clearly see in the chart, is downwards.
Illustration: National debts in % of GDP
Source: IMF, Fed
Another striking feature of the chart is the development in the US mentioned above. It has seen the sharpest rise in national debt in recent decades. However, it is the outlook that is most alarming. The chart also contains the forecast of the International Monetary Fund in dotted lines at the current edge. The US is the only country analysed where an increase is shown for the coming years. Even without the assumption of further crises, the US debt ratio continues to grow significantly.
Risks of increasing debt
There is no scientifically established, clearly defined upper limit beyond which a debt ratio would be problematic. However, if the ratio rises over a longer period of time, this is usually a sign of unsustainable government financing and indicates the need for reform. This can take a long time and the timing of the correction is difficult to predict. However, the costs of interest service are directly noticeable. If the national debt increases, an increasing proportion of government revenue has to be used to cover interest payments and is not available for other purposes. The US, for example, has long spent significantly less than 10% of tax revenue on interest payments. If debt continues at the same rate, it will be 20% in ten years’ time and even a third by 2050. This scenario assumes that interest rates remain unchanged. However, the higher the level of debt, the more likely it is that interest rates will start to rise, as debtors will want to be compensated for the risk of (partial) payment defaults. If such a process starts, a country can be threatened with national bankruptcy in extreme cases.
The US is in the advantageous position of being able to raise foreign debt in its own currency. It is therefore likely to take longer for such interest rate premiums to materialise. However, if US government bonds were to lose their role as ‘safe assets’, massive global financial turbulence could be expected. It is therefore reasonable to hope that concerns about the sustainability of government debt will soon regain the importance they deserve in the economic policy debate in the US. A correction of the current course would be long overdue.
Responsible
Prof Dr Aymo Brunetti
Economist, Professor of Economic Policy at the University of Bern
Sybille Wyss
Chief Executive Officer
s.wyss@tareno.ch
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[Images: Marijke Vosmeer]