Governments around the world have taken stringent measures to contain the spread of COVID-19, which have been crucial to save lives but have come at a huge economic cost. Our Research analysts expect the global economy to shrink 3.5% in 2020. It is likely that advanced economies will bear the brunt of this slowdown, contracting an anticipated 7%, compared with a pre-COVID growth estimate of 1.5%.
To support businesses and individuals through the COVID-19 crisis, governments have also provided unprecedented fiscal support. Trillions of dollars have been spent on loans, grants, unemployment benefits, healthcare and a raft of other measures.
In the latest ‘3 Point Perspective’, our Research team examines the longer-term consequences for some of the leading G20 countries and considers the fiscal measures governments can take to alleviate their growing debt burdens.
The fiscal profiles of advanced economies are set to worsen quite dramatically, although the deterioration is uneven across economies:
Source: CBO, OBR, Eurostat, Barclays Research
Policy-makers will not be able to ignore these worsening fiscal profiles for long, as rising debt would ultimately be detrimental to growth. With the US dollar as the reserve currency and US Treasury debt as the preferred 'safe asset', policymakers in the US have the luxury of being more patient. However, without a fiscal union, the euro area remains vulnerable, as does the UK, with Brexit-related uncertainties
Broadly, there are four options to address the rising debt burden. The preferred policy options and their success will depend on each country’s specific situation.
Boost economic growth: Governments can enact pro-growth policies to lower the debt burden through greater tax revenues and higher GDP levels.
Cut budget deficits: Increasing taxation and reducing spending both work to reduce the gap between government revenues and spending.
Inflate away debt: By relying on higher inflation, governments can reduce the real value of outstanding debt.
Engage in financial repression: With central banks buying or promising to buy debt, governments can issue debt at low rates, thus keeping the cost of servicing debt low.
A fifth possibility - debt restructuring - is not a feasible policy for major developed markets.
Given the limitations of each of these options, governments would need to take a comprehensive approach to address the rising debt burden.
Financial repression policies will probably be the path of least resistance. However, they are not without costs. Central bank involvement beyond that justified by the economic backdrop would call into question their independence. Hence, while these policies are likely to be used to buy time for vulnerable countries, they cannot be relied upon forever.
Achieving fiscal consolidation has limits, as well. Following the austerity measures after the global financial crisis, there is little public appetite for further cuts in services. There is, in fact, demand for more spending, such as on healthcare, education and infrastructure. Policymakers are better served by enacting policies that boost growth via encouraging more people to work, as well as via greater private and public investments. Increased taxation is likely to be part of the solution.
Finally, inflating away debt is easier said than done. Inflation has been quite sticky at low levels and if it does rise sharply, investors would also demand higher interest rates, offsetting the benefit of higher nominal growth. Still, a post-COVID world of modestly higher medium-term inflation, if it occurs, could be welcomed by policymakers.
Source: Haver Analytics, Barclays Research
Overall, while there is no easy way out, developed economies are in a strong position to put their fiscal houses in order and are likely to consider their options carefully in the coming years.
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