Europe’s Spending Could Spark a New Debt Crisis

  • A new debt crisis could loom as European countries throw huge sums into the energy crisis.
  • “I think some will struggle to avoid debt problems in the coming years, and the outcome will be painful,” a Stanford economist told Insider.
  • This could result in interest rates staying higher for longer or trigger a sharp change in policy to stabilize the economy.

Europe is facing a macroeconomic storm. Amid an energy crisis, sky-high inflation and a possible recession, some experts believe some European nations could be facing a new debt crisis as governments step up spending to protect consumers from rising energy costs.

The crisis largely stems from Russia cutting gas supplies to the continent, which has pushed up energy prices and forced governments to intervene with tax cuts, price controls, consumer subsidies and other pain relief measures – all while offsetting higher ones Debts .

The UK, whose debt accounted for 143% of its GDP last year, has spent the equivalent of €178 billion so far to combat the energy crisis – the most of any country in Europe, according to data from think-tank Bruegel. France, whose debt was 145% of its GDP last year, has budgeted €71 billion and Germany, whose debt is 77% of its GDP, has handed out €100 billion before approving another €200 billion bailout.

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Much of this spending will be funded by more government bonds. But the challenge of paying off that debt later is where problems arise, according to Michael Boskin, an economist at Stanford University.

“I believe some will struggle to avoid debt problems in the years to come, and the outcome will be painful,” Boskin told Insider. “And in the past, highly indebted countries end up having problems. They could have a financial crisis, they could fuel inflation.

While each country’s debt situation is unique, Boskin notes that spending is a big problem for Europe as a whole: southern European countries like Greece historically have higher debt and deficits than northern European countries. But northern European countries are facing a colder winter, meaning they risk having to shell out the most money to protect their citizens as the continent’s energy supplies are cut.

It is already estimated that the energy crisis has cost Europe around 700 billion euros. That can further weaken European economies for three reasons, says Boskin:

  1. Inflation has already rocked the continent. Inflation in the Eurozone was 10% in September. Combined with a high debt burden, that spells trouble, says Boskin, because debt itself is also inflationary.
  2. Some countries are struggling with weaknesses in their banking systems. He pointed to Italy as an example, where the banks needed help from the government. Additional spending and debt from the energy crisis could put more strain on the financial system.
  3. Some nations are dealing with political tensions. Boskin referred to the Maastricht Treaty, which sets a 3% ceiling for EU countries’ budget deficits and a rule of no more than 60% for the public debt-to-GDP ratio. Increasing these requirements to adjust for additional spending could trigger further political turmoil.
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“Throwing the energy shock on top is a huge economic stress. If anything else should go wrong, there are no more shock absorbers,” he said.

Is there a crisis?

The path through the macro-storm isn’t entirely clear, and the answer isn’t necessarily to slow government spending to ease the energy crisis, according to Jennifer Lee, an economist at the Bank of Montreal.

“I think given the enormous amounts, there could very likely be a debt crisis [are] expressed as a percentage of GDP. While it’s necessary, similar to pandemic spending, it will add to the high debt mountain that has already accumulated,” Lee said.

Other experts believe the likelihood of a debt crisis is slim and the priority should be to ease the pain of high energy prices, which Eurostat says were the main cause of inflation in the euro zone.

“Inflation is the massive threat,” David Wech, Vortexa’s chief economist, told Insider. He pointed to the recent fall in fuel consumption, a sign that inflation has already hit economic activity. Gasoline imports to the Atlantic Basin, which includes Europe, fell 15% monthly in September, four times the usual seasonal decline.

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“Helping consumers and businesses deal with much more dramatic increases in electricity prices is essential to mitigating the impact on economic activity… The bigger risk is high prices and inflation. I personally think [a debt crisis] is a minor role,” he said.

And if the high debt burden pushes Europe to a critical juncture, the result may not be a financial crisis, Boskin notes, although it could prompt a rapid change in government spending or taxes in some countries.

“Nobody can predict exactly when [but] The gradual pain adds up to something substantial, and at some point there has to be an abrupt change,” he said.

What is certain, however, is that rates will be higher for longer than expected — on the order of 12 to 18 months rather than six to 12 months, Boskin noted. He estimated that an ECB hike in interest rates above 4% could be “very painful” for households, particularly for homes borrowing on adjustable-rate mortgages. And if inflation continues to rise for an extended period, the monetary policy needed to stabilize the economy could be even more disruptive.

“I don’t think it’s inevitable. But once you’re aware of the risks, it would be far less risky to tackle the underlying causes soon,” Boskin warned.

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