WSJ – As U.S. Debt Surges, Europe Brings Its Own Under Control

US debt vs. Eurozone:

https://i.imgur.com/08AbGbX.png

US projected deficit vs. European countries with recent debt crises:

https://i.imgur.com/YThSVYB.png

Article link: https://www.wsj.com/economy/global/as-u-s-debt-surges-europe-brings-its-own-under-control-2ea6e58b

• Lessons of the euro crisis, and rules agreed to years ago, are stemming red ink in Europe as it gushes in U.S. and China
• In projections released earlier this month, the International Monetary Fund projects U.S. deficits for all governments will reach 7.4% of GDP in 2024 and 2025.
• But in Europe it is a different picture. The IMF expects combined deficits of eurozone governments will fall to 3.4% of GDP this year from 3.6% in 2022, and further to 2.7% in 2024.
• Those countries that were in crisis a decade ago are expected to have much smaller budget gaps. In Greece, the deficit is forecast to fall to 1.6% of GDP from 2.3% last year, while Portugal’s is expected to fall to 0.2% of GDP from 0.4%. Ireland is forecast to have a budget surplus for the second straight year.

Throughout the Covid-19 pandemic and then Russia’s invasion of Ukraine, both the U.S. and Europe borrowed heavily. Now with those emergencies in the rearview mirror, a divergence has emerged: Even as the U.S. continues to let deficits rip, Europe’s are on track to narrow significantly.

This is in contrast to a decade ago, when deficits in the wake of the global financial crisis pushed some members of the euro area to the brink of default. The lessons of that episode, coupled with eurozone rules, have served to impose discipline on European governments that for now is entirely absent in the U.S.

They are getting little credit for it. Government bond yields have risen worldwide in the past month. While many factors are at play, including efforts by central banks to bring inflation back down, another key factor is the U.S. deficit.

The U.S. government Friday said its deficit rose to $1.7 trillion, or 6.3% of gross domestic product, in the year ended Sept. 30, from $1.4 trillion, or 5.4% of GDP, a year earlier. Without an accounting change related to the administration’s aborted student-loan-cancellation program, the deficit would have been closer to $2 trillion, a doubling from the prior year.

In projections released earlier this month, the International Monetary Fund projects U.S. deficits for all governments will reach 7.4% of GDP in 2024 and 2025.

But in Europe it is a different picture. The IMF expects combined deficits of eurozone governments will fall to 3.4% of GDP this year from 3.6% in 2022, and further to 2.7% in 2024.

Those countries that were in crisis a decade ago are expected to have much smaller budget gaps. In Greece, the deficit is forecast to fall to 1.6% of GDP from 2.3% last year, while Portugal’s is expected to fall to 0.2% of GDP from 0.4%. Ireland is forecast to have a budget surplus for the second straight year. Italy and France, among others, continue to have deficits of roughly 5% of GDP.

“It’s really quite striking how the paths have diverged,” said Christian Keller, chief economist at Barclays. “There doesn’t seem to be any effort in the U.S. to bring spending down or raise revenues.”

If those forecasts turn out to be accurate, European governments will no longer be a leading driver of the increase in the world’s debts. The IMF estimates that government debts are set to rise by 1 percentage point of economic output over the coming years, but almost entirely due to the U.S. and China. Without them, the debt load would be falling.

A little more than a decade ago, Europe was the focus of global anxieties about surging government debts. Greece, Portugal, Ireland and Cyprus were bailed out; Greece defaulted on some debts. Between the resolution of that crisis through bailouts and support from the European Central Bank, and the start of the pandemic, most European governments had narrowed their deficits.

By contrast, the U.S. deficit began to exceed its European counterparts’ in 2016, and the U.S. also borrowed more heavily during the pandemic. Crucially, it doesn’t seem to have a path to narrowing those deficits: the Biden administration has proposed tax rises that Republicans and some Democrats in Congress reject, while Republicans seek spending cuts that the administration won’t countenance.

The broad outlines of the European Union’s budget rules were laid down in 1993 as part of the Maastricht Treaty that paved the way for the euro and stipulate that budget deficits should not exceed 3% of GDP. Those rules were suspended in 2020 to allow governments to respond to the pandemic and then extended to allow support to households during the surge in energy prices following Russia’s invasion of Ukraine. As a result, deficits widened and debts rose.

The projected decline in European deficits mostly reflects the winding down of that emergency support.

But beyond that, painful memories of its debt crisis are likely to ensure that Europe’s governments are more averse to rising deficits.

“We need to bring the public finances back on track,” said Valdis Dombrovskis, the EU official responsible for enforcing the budget rules, at a news conference Tuesday. “Fiscal policy needs to stay prudent.”

European governments don’t want the rules to remain exactly as they were before the pandemic suspension. One significant criticism is that rather than restrain day-to-day spending, the rules have prompted governments to hold back on investment that boosts long-term growth, including to make Europe’s economy greener. Some governments want the new rules to exempt certain kinds of investment spending, while others believe that will make the rules too loose. Since they have not yet found consensus on changes, they may end up subject to the old constraints in 2024.

The U.K. has a different set of self-imposed rules, but also aims to get its budget deficit below 3% of GDP over the coming years. It had a debt scare in late 2022, when then Prime Minister Liz Truss announced a surprise package of large tax cuts, sparking a selloff in the government bond market.

Truss was quickly replaced by Rishi Sunak, whose government has instead raised taxes in an effort to bring its debts down by freezing the thresholds at which income-tax rates rise. As incomes increase in line with rapid inflation, more people move into higher tax brackets.

The U.K.’s nonpartisan Institute for Fiscal Studies estimates the freeze could raise an additional £52 billion, equivalent to $63.26 billion, in tax revenues by the fiscal year ending March 2028, or the equivalent of an increase of 6 percentage points in income-tax rates.

Not all European governments are willing to be quite that tough. Both Italy and France have recently announced budgets that see a slower decline in deficits to below the 3% target than initially anticipated. The European Commission could declare the Italian government in breach of the rules, thereby denying it access to a European Central Bank program designed to counter sharp rises in borrowing costs.