How higher interest rates will squeeze government budgets?
In recent years government debt seemed to matter less and less even as countries borrowed more and more. Falling interest rates made debts cheap to service even as they grew to levels that would have seemed dangerous a generation before. The pandemic put both trends into overdrive: the rich world borrowed 10.5% of its GDP in 2020 and another 7.3% in 2021, even as long-term bond yields plunged. Now central banks are raising interest rates to fight inflation and debt is becoming more burdensome. Our calculations show that government budgets will feel a squeeze far more quickly than is commonly understood.

In May America’s budget officials raised by a third the forecast cumulative interest bill between 2023 and 2027, to 2.1% of GDP. That is lower than forecast before the pandemic, but it is already an underestimate. Officials optimistically assumed the federal funds rate would peak at 2.6% in 2024, but markets now expect the rate to exceed 3% in July 2023. In the euro zone, as interest rates have risen, the premium indebted countries like Italy must pay to borrow has gone up, reflecting the danger that their debts may eventually become too onerous to service. Britain’s officials forecast in March that its government would spend 3.3% of its GDP servicing its national debt in 2022-23, the highest share since 1988-89.


Source: https://www.economist.com

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