DEALING WITH THE UPWARD DRIFT IN GOVERNMENT DEBT
Developed market (DM) governments accumulated massive debts during the global financial crisis—which they appear reluctant, or unwilling, to tackle. The U.S., for example, is deploying a significant, unfunded tax cut, European voters are demonstrating austerity fatigue and Japan is kicking the can down the road.
We ask what a successful DM public debt consolidation would look like, based on successful past consolidations, and consider the obstacles today as well as the long-term investment implications.
What are potential long-term risks? If they do tackle debt, our interest rate and growth projections may need to be lowered. If debt is not tackled, there is the risk of a political challenge to central bank independence, to lower rates to help ease the debt service burden.
Historically, the key ingredients of DM public debt consolidations were favorable monetary policy, a positive growth environment and lowered government spending—belt tightening. As for the first two, policy and growth, our long-term macroeconomic and market expectations do not foresee any tailwinds. When it comes to attempts to lower fiscal spending, demographics (an aging electorate that will defend its health and social benefits at the ballot box) will pose a challenge. And a populist backlash against migration, globalization and automation may further disincline DM governments from cutting social supports.
Given those constraints, successful debt consolidation will be likelier for countries with a more favorable mix of interest rates to growth, or a tailwind from currency depreciation. Absent those, we argue that central banks will bear much of the burden of debt consolidation in the coming decades—they may be put under political pressure to maintain loose monetary conditions. as governments seek lower rates to reduce their interest payments. In theory, monetary policy should remain independent, focused on containing inflation and sustaining employment. The reality might prove trickier.
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WILL DEVELOPED ECONOMIES TACKLE THEIR MASSIVE PUBLIC DEBTS?
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2019 Long-Term Capital Market Assumptions