Introduction
The scale and servicing cost of government debt are both rising. This will increase the amount of money that governments will have to suck out of economies over the next 10-15 years. Only Argentina so far has diverged from established convention, and reined in its spending. That appears to be anathema to European governments, and who can say what the trajectory is for the USA.
Budget deficits and the hangover from the period of ultra-low interest rates
Major Western economies are almost all running budget deficits, and their spending has not been reined in even as the crises have passed that were used to justify its increasing. The specific crises include the Global Financial Crisis, the Eurozone sovereign debt crisis, and Covid-19, with Ukraine as this week’s hot topic, and the ongoing Climate Crisis as a contingency in case nothing else presents itself to spend money on.
Central banks agreed that low interest rates and bond buying were needed as crisis responses, in order to bring liquidity to markets and to reflate economies.
The popular ‘Modern Monetary Theory’ was that it was immoral of governments not to borrow as much as they possibly could at these low rates in order to spend it ‘on the public good’, no matter what the consequences as regards inflation or the over-loading of the country’s payment capacity on account of the capital repayments, even if the interest rate was low.
The prevailing orthodoxy was in favour of creating inflation, as this would reduce the value of the debt in real terms, making repayment easier. Accelerated GDP (Gross Domestic Product) growth – even if not causing wealth creation – and inflation were welcomed as ways of enabling governments firstly to appear to be solvent by ratios such as debt-to-GDP, and secondly to meet their obligations as they fell due, on the assumption that GDP growth and inflation would trigger higher tax receipts.
It does not appear to have troubled governments that this policy punished the investors upon whom governments depended for their financing: investors lost value in real terms. It is amazing that investors took so long to realise that this is what was being done to them.
In 2022 traditional monetary theory took back the controls: interest rates were increased to control rising inflation. Medium-term interest rates – controlled by the markets – remain above inflation as investors require a premium over it. Overnight interest rates – controlled by central banks who dance to the tune of governments in most cases – are at or below inflation.
Short-term and medium-term rates are being pulled in opposite directions: at what point does the chewing gum that connects the two snap?
Current status
Here are the figures at the end of 2024 for major countries as regards (i) their fiscal deficits as a percentage of their GDP, and (ii) their debt-to-GDP ratios:1
| Country | Fiscal deficit | Debt-to-GDP |
| Germany | 2.8% | 63% |
| France | 5.8% | 113% |
| Italy | 3.4% | 135% |
| UK2 | 4.8% | 96% |
| USA | 6.2% | 124% |
All five countries are running a fiscal deficit, and both France’s and Italy’s are outside their EU treaty commitments, leading to their being put into the EU’s Excessive Deficit Procedure.
Disconnect between GDP growth and wealth creation
Politicians seem to regard ‘GDP growth’ and ‘wealth creation’ as synonyms. It is hard to imagine wealth creation occurring where GDP is stagnant, but there can be numerous reasons why an expanding GDP does not create wealth:
- Where ‘growth’ is concentrated in the compartment of GDP that is paid for by the government and by taxes: if that increases, wealth could be reduced;
- Where ‘growth’ is simply price increases, such as in Q1 2025 in the UK where a main driver of ‘growth’ was higher sewage disposal costs;
- Where nominal ‘growth’ is lower than inflation: then ‘real’ GDP has shrunk and probably wealth with it;
- Where ‘growth’ is the spending of borrowed money, all the better if the borrowings do not count within official measures of debt but their spending does count within GDP;
- Where the profit margin on the increase in activity is artificially shifted within a corporate group, for example into its Irish subsidiary from its German, French or UK one;
- Where a labour force is used to fulfil the increase in activity that is on low wages and causes no tax liability in the country where the growth is recorded, but which utilizes its public services: that causes wealth destruction in the target country.
Cost of new government debt
We can compare the cost now of new government debt with where it stood in at the start of 2022, using the country’s 10-year government bond yield as the illustrator:3
| Country | 2022 | 2025 | Change |
| Germany | -0.1666% | 2.5700% | +2.7366% |
| France | 0.2890% | 3.2450% | +2.9560% |
| Italy | 1.2121% | 3.5790% | +2.3669% |
| UK | 1.1970% | 4.6330% | +3.4360% |
| USA | 1.7727% | 4.3980% | +2.6253% |
Today’s rate will be the cost for these governments of their borrowings to meet:
- Their fiscal deficit for the year;
- Refinancing of maturing debt, since they have no fiscal surplus with which to meet maturities;
- One-off costs, such as, in the case of the UK, the losses on the Bank of England’s Asset Purchase Programme, caused by its having bought fixed-interest bonds during the period of ultra-low interest rates.
The drag of hidden debts
One should then factor in the need to repay the debts taken out at the behest of governments in order to respond to crises, but where the borrower is not a national government, albeit that the borrowing is structured so as to make the source of repayment the same as it is for the national debt: the country’s businesses and individuals.
In the EU there is:
- NextGeneration EU: €750 billion and a response to Covid-19, where the EU is the borrower;
- InvestEU: now €1.7 trillion and a response initially to the Eurozone sovereign debt crisis, then repurposed to deal with the Climate Crisis, where project companies are the borrowers.
In the UK, schemes are emerging to deal with the Climate Crisis, which will borrow 70-80% of the project cost. The remainder will be inserted by new public entities such as Great British Energy and the National Wealth Fund, whose investments will be financed by new borrowings taken on by central government. The UK’s Carbon Budget infers a capital cost for such schemes of £50 billion per annum at least until 2050, adding up to £1.25 trillion, without the ‘budget’ including the interest either on the government’s new debt or the debt taken on privately.
All of those schemes will require debt service to be extracted from the respective economies, whether through national or local taxes, levies, tolls, usage charges or any of the other mechanisms through which authority bodies elicit money from businesses and individuals.
Policy responses by governments
The main policy responses in evidence are the hiding of the build-up of new debt, and widening the scope of the tax base (making new things taxable) and increasing tax rates.
To this end the UK is leading the way:
- Freezing personal tax allowances so that wage inflation makes more people pay income tax at the 20% basic rate, and pushes more of their income into the 40% higher rate band;
- Making private school fees subject to Value-Added Tax;
- Increasing the rate of Capital Gains Tax on profits on shares to 28%, the same rate that prevails on profits on residential real estate;
- Doubling the rate of local taxes on residential properties that are not the owner’s principal private residence.
In parallel the UK re-writes its own fiscal rules to make the current budget deficit appear more acceptable to itself and, with any luck, to voters. Investors and public credit rating agencies may not be so easily convinced.
On the Continent the EU plans to increase its own borrowings for re-armament, in yet another hidden debt scheme like NextGeneration EU.
In Germany the new coalition, having released the Debt Brake, plans to increase the country’s budget deficit and to create new ‘funds’ (i.e. permissions to itself to borrow and spend) for expenditure on re-armament and on infrastructure. The first duplicates the EU’s new scheme; the second one duplicates InvestEU. As the aim appears to be to raise Germany’s debt from 63% to 83% of GDP over a ten year period, that risks the fiscal deficit going above 3% – enough to put Germany into the EU’s Excessive Deficit Procedure.
Of course if the debt is spent in such a way as to statistically raise GDP, the deficit may remain below 3%, but that is questionable with defence spending. The objects purchased require on-going crewing and maintenance, which are extra lines of expense to the fiscal budget, and they produce no goods or services that feed into GDP, and they deliver no tax revenues.
By contrast one notes that France and Italy have not yet followed suit and announced plans to further increase their borrowings, probably because their debt-to-GDP ratios are already well over 100%, and that does not include any factoring-in of their shares of the hidden debts.
The USA attacks waste at the Federal level through the DOGE programme, and has announced increases in import tariffs as a major source of new income with which to service the disastrous budget situation bequeathed by Biden with his Bidenomics/Securonomics.
Now, though, it is less certain that the tariffs will bring in the planned amounts. If Trump nevertheless cuts taxes, how will be the budget hold together other than via new borrowing? This seems to be Moody’s Ratings’ concern in cutting the USA’s public credit rating from Aaa to Aa1.4
Conclusion
Governments seem both unable and unwilling to cut spending and reduce their costly interventions. Rather than governments learning lessons and retrenching, there is always a good reason for a new intervention: Ukraine and rearmament now, with the Climate Crisis being good for another fifteen or twenty years at least.
The payback period for the cost of past interventions is now starting, for example in the case of the early InvestEU schemes. The carrying-cost of current government debt is increasing year-on-year as new deficits have to be financed, and as debt taken on at very low rates of interest in the period 2010-2022 matures and has to be refinanced: both cause a need for new debt at today’s far higher interest rates.
Servicing this rising mountain of obligations will impose a growing burden on businesses and individuals and cannot fail to result in overall stagnation, possibly punctuated by the occasional burst of growth, albeit that the growth may be statistical only: the recording of the spending of yet another amount of debt.
More likely there will be short recessions, making it difficult for governments to extract the money they need. Governments would dearly like to go back to 2010-22, with ultra-low interest rates and a degree of inflation, reducing the value of their own debts. Central banks (but not Jerome Powell of the Fed) appear to be willing to go along with that, but bond investors will not: they were burned too badly during 2010-22 and will continue to require returns above inflation.
At some point, and somewhere, these conflicting agendas ought to collide in the real world. Equally likely we run further and further into the sand, in endless and intractable stagnation, without matters ever coming to a head.
1 https://tradingeconomics.com/countries accessed on 16 May 2025
2 The UK’s national debt is ‘Public sector net debt’, and the original ‘Public sector gross debt’ has been subjected to numerous, questionable reductions to reach this net figure
3 Trading Economics: 14:15 UK time on 16 May 2025
4 https://www.reuters.com/markets/us/moodys-downgrades-us-aa1-rating-2025-05-16/
