Due to the Coronacrisis, the public debt of many countries rose sharply. With the low-interest rate we had, this was not a big issue. However, the interest rate is rising. Should we be afraid of another financial crisis? Casper de Vries, Professor of Monetary Economics at Erasmus School of Economics, explains what we can expect from these macro-economic changes in Trouw (28 April 2022) by elaborating on two scenarios.
Scenario 1: It may not be so bad this time
The European Union learned from the financial crisis ten years ago. Thus, measurements have been taken to prevent member states from descending into crisis. For instance, a special emergency fund containing 500 billion euros has been established in 2012. The Professor doubts whether this fund will be sufficient. Currently, Italy alone has a public debt of 2700 billion euros. However, he does agree that this fund may alleviate any concerns in the financial market. Thereby preventing member states from going down due to high-risk premiums.
Scenario 2: A new financial crisis
What if the measurements turn out to be insufficient? What will then be the consequences? After all, many member states lost their budgetary discipline when Corona kicked in. Maintaining discipline is tough when there is little to no interest to pay over large quantities of borrowed money. Although the risk seemed low back then, the interest rate is rising steeply. De Vries calculates that the interest rate on Italian ten years government bonds has already risen by two percentage points (from 0,6 percent to 2,5 percent). With such a rise in interest rate, the Italian economy needs to grow at least 3 percent per year to sustain the current government debt. The professor doubts whether this will be feasible. For the past few years, the Italian economy was unable to achieve these growth rates.
Conclusion
It is unsure how the new safety measures and emergency funds will work if a new crisis erupts. Especially given the vicious banking-government circle, where banks have above-average holdings of their own government bonds on their balance sheets. Professor de Vries is indecisive about the outcome, and afraid of what is to come.