Public Debt

Overall, however, the government debt ratio in the EU27 fell to 77.5 percent by 2019. Some countries, such as Germany and the Netherlands, even managed to reduce their debt-to-GDP ratio to a lower level than before the financial crisis. Nevertheless, many European countries still had a higher public debt ratio before the Covid-19 crisis than before the onset of the financial crisis.

The coronavirus pandemic led to a significant economic slump and an increase in government aid and support measures. Debt has increased dramatically in many countries as a result. In Germany, the public debt ratio is expected to rise from just under 60 percent to at least 75 percent of GDP, in France to just under 120 percent, in Italy to almost 160 percent, and in Greece to levels above 200 percent.

Debt Is an Important Instrument of Fiscal Policy

However, government debt is not bad per se. In fact, government debt is an important instrument of fiscal policy, and increasing it is the right thing to do in a crisis. The targeted use of government debt can support the economy and incomes and avoid a major economic slump.

At the same time, it’s important to change course again in good time following a crisis. At present, low, in some cases even negative, interest rates make it possible to live with high government debt without overburdening public budgets with interest payments. In addition, many investors look for safe investment opportunities during the crisis, which include government bonds, at least from the financially more stable countries in Europe. However, the low interest rates will remain only as long as creditors have the confidence that they will get their money back safely.

The coronavirus pandemic will certainly not be the last economic crisis. It is important to reduce the debt ratio in the years following a crisis so that new scope is available for stabilization when the next economic slump rolls around. That is why it is important for Germany and Europe to commit to bringing the debt ratio back down toward 60 percent of GDP in the medium term.

This policy would not only create room for maneuver for the future, but also strengthen creditor confidence and keep interest costs low. The least painful way to pay off the national debt is through economic growth. If spending cuts and tax increases become necessary as well, those burdens should be distributed fairly and economic growth impaired as little as possible.