What fiscal-policy-related consequences can we expect to result from the multi-billion COVID-19 relief measures?


Harald Badinger, Head of the Institute for International Economics

Dramatic developments in individual EU member states

In 2007, just before the onset of the global financial and economic crisis, the average public debt of EU member states was 62% of the gross domestic product (GDP). Today, one year after the onset of the COVID-19 pandemic, it has risen to 94%. These averages do not adequately represent some of the much more dramatic developments in individual EU member states: In France, public debt has risen from 65% to 116% since 2007, in Portugal from 73% to 135%, in Spain from 36% to 120%, and in Greece from 103% to 207%. Austria’s current debt level of 84% is below the EU average, but well above Germany (71%) and the Netherlands (60%). In 2007, Austria’s public debt ratio was still 65%.

No dramatic consequences for fiscal policy

In the short term, this won’t necessarily result in dramatic consequences for fiscal policy, as states can borrow and refinance at very low cost thanks to the currently generally low interest rates; and due to unconventional monetary policy measures put in place by the ECB (quantitative easing, bond purchasing programs), this also applies to European states with below-average credit ratings, meaning that these states can incur additional debt at below market prices.

Interest rates are expected to rise as a result of an increase in inflation rates

However, this situation is not expected to continue in the medium to long term. Interest rates will go up again due to the economic recovery after the end of the pandemic and likely rising inflation rates. As a result, interest charges, i.e. the part of government revenues that has to be used for interest payments, will increase significantly. Due to budget restrictions, these funds will then be lacking elsewhere (e.g. in the area of public investments), restricting states’ scope for fiscal policy actions. The ECB’s crisis policy will also not be carried over unchanged when things return to “normal”; as a result, the increase in interest rates will be particularly sharp for less solvent countries, which will cause problems for these states not only in making their interest payments but also in refinancing their debts.

Reduction of public debt a must

If they act with foresight, the (EU) states will then have to reduce their public debt after the crisis is over – moderately and spread over time, but nevertheless consistently – in order to remain independent in their fiscal policy and secure their credit ratings so that they can refinance debt or take on new debts. Both will be needed, not least in order to be prepared for the next weak economic phase or the next economic crisis – hopefully in the distant future – and to be able to respond with fiscal policy measures.

Harald Badinger, Head of the Institute for International Economics

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