The deteriorating US fiscal position is the most glaring among advanced economies. But the Eurozone general government deficit has been widening too, hitting 4.1% of GDP in Q4 2023. The ECB has attempted to quantify the cumulative fiscal burden arising from demographic ageing, the end of the “peace dividend”, and climate change. Starting from today’s debt levels, in order to achieve a government debt-to-GDP ratio of 60% by 2070, Eurozone governments would have to immediately and permanently increase their primary balances by 4.8% of GDP, on average.
It should be stressed: these numbers contain a large degree of uncertainty. Higher defence spending could potentially boost technological progress, for example, and therefore growth. On the other hand, the estimated cost of climate change is probably too low, given that it is premised on limiting global warming to 1.5°C, which is now virtually impossible.
Mario Draghi also delivered some important remarks back in February, echoing the ECB research. In particular, he noted that large, negative supply shocks will become more frequent and in response, public deficits will have to be persistently higher.
In short, climate change, higher defence spending & demographics will put immense pressure on the public finances. But the required fiscal consolidations are so large, as to be politically unpalatable for many Eurozone nations. Fiscal adjustments of the size proposed by the ECB would risk playing into the hands of populists and the far right, who performed well in the recent European elections. With the Eurozone falling further behind the US in the productivity race, European institutions and governments will have to be bigger and bolder, and this is what Mario Draghi will propose in his upcoming productivity report. Eurozone deficits are likely to continue exceeding forecasts, which will be an additional source of upward pressure on sovereign bond yields globally over the longer-term.
