Fiscal Challenges Faced by New European Governments


Newly elected European governments are confronted with challenging financial circumstances, as they are required to implement change despite having limited resources.

Recent elections have resulted in new leadership in France and the U.K., where public debt is at multi-decade highs. The economic growth is sluggish, borrowing costs have increased, and demands on public funds are increasing, all of which are above pre-pandemic levels. Additionally, government expenditure and budget deficits are still present.

Economists anticipate that fiscal restraint—whether through increased taxes or diminished spending—will be required. Nevertheless, political leaders have failed to adequately prepare voters for such measures, instead promoting ambitious new expenditure plans.

The far-right National Rally, which is anticipated to secure the most seats in parliament, has suggested tax cuts and the reversal of the pension age increase in France. The left-wing New Popular Front, on the other hand, has an even more ambitious agenda that includes price freezes and minimum wage hikes, but it does not address the deficit. The yields on French government bonds have increased, and in May, Standard & Poor’s downgraded the country’s sovereign debt rating.

The Labour Party in the United Kingdom, which currently holds a historic majority, intends to increase the funding of public services such as the National Health Service, despite the fact that their proposals are relatively modest. The Institute for Fiscal Studies criticized major parties for failing to make difficult fiscal decisions.

In France, public debt has increased to 112% of GDP, while in the United Kingdom, it has risen to 104% of GDP, according to the International Monetary Fund. Even Germany, which has historically been fiscally conservative, has transitioned from budget surpluses to deficits. Recently, Chancellor Olaf Scholz’s coalition reached an agreement on a budget that will increase military expenditure and economic development.

Public debt in the United States is currently at 123% of GDP, which presents an even more difficult situation. Due to the dollar’s reserve status and robust economic growth, there is minimal political pressure to resolve the deficit, which renders U.S. bonds more appealing to investors.

Strong economic growth and reductions in military expenditure have historically been effective strategies for reducing high public debt levels; however, the current environment presents a challenge in achieving such reductions. The likelihood is that public expenditure on healthcare and pensions will increase as a result of the current elderly population. This raises concerns that investors may ultimately hesitate to purchase government bonds.

The Kiel Institute for the World Economy has conducted a study that indicates that populist governments have a negative long-term economic impact, including higher debt and inflation, as well as lower GDP growth. Prime Minister Giorgia Meloni of Italy has thus far avoided investor backlash by moderating spending plans.

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