Europes New Governments Face Financial Challenges

Byadmin

Jul 8, 2024
Europes New Governments Face Financial ChallengesEuropes New Governments Face Financial Challenges

The newly elected governments in Europe are facing difficult financial situations and are tasked with implementing reforms in a situation of limited resources.

State debt is close to its highest levels in decades in both France and the United Kingdom, where recent elections have brought in new leadership. State expenditures and budget deficits remain above pre-pandemic levels, economic growth is weak, borrowing costs are rising, and demands on public finances are increasing.

Economists suggest that fiscal constraints will be necessary – through reducing expenditures or increasing taxes. However, political leaders have not prepared voters for such measures, instead promising new ambitious plans.

In France, the far-right National Rally, expected to gain the most seats in parliament, has proposed tax cuts and reversing the increase in the retirement age, while the left-wing New Popular Front has an even more ambitious program, including freezing prices and increasing the minimum wage without committing to deficits. France’s government bond yields have sharply risen, and in May, Standard & Poor’s downgraded the state debt rating.

In the United Kingdom, the Labour Party, with a historic majority, plans to increase spending on public services like the National Health Service, although their proposals remain moderate. The Institute for Fiscal Studies has criticized the major parties for avoiding difficult fiscal decisions.

According to the International Monetary Fund, public debt in the United Kingdom has risen to 104% of GDP, and in France, to 112% of GDP. Even traditionally fiscally conservative Germany has shifted from a budget surplus to a deficit, as Chancellor Olaf Scholz’s coalition recently reached an agreement on a budget aimed at stimulating economic growth and military spending.

The United States faces an even greater challenge, as their state debt stands at 123% of GDP. However, political pressure to address the deficit is weak thanks to stable economic growth and the reserve status of the dollar, making U.S. bonds more attractive to investors.

Historically, high levels of state debt have been reduced through strong economic growth and cuts in military spending, but current circumstances make such measures difficult. Increased public expenditures on healthcare and pensions due to an aging population are likely to rise further. This raises concerns that ultimately investors may hesitate to buy government bonds.

Italy’s Prime Minister Giorgia Meloni is currently avoiding reactions from investors by moderately limiting spending plans, but according to a study by the Kiel Institute for the World Economy, the long-term economic impact of populist governments is usually negative, with higher debt and inflation and lower GDP growth.

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