Hardly any mature economy is undergoing a recession. Since the end of the Covid-pandemic, public debt has slightly fallen in real terms due to inflation. Although interest rates have risen, they still remain below the economic growth rate. So, you may wonder, what is the problem? I am afraid that there is a problem when looking at the situation more thoroughly.

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The French pay the highest taxes (46%) of all European Union member countries. French politicians hate to make budget cuts to balance government’s books. France’s debt is 113% of the country’s GDP – a very high percentage indeed.  One would have hoped that France would be the exception to the rule of fiscal frugality. However, quite a few rich countries are knee-deep in debt; pundits talk of a looming debt crisis.

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Britain, Japan, and the United States, just to mention a few, live beyond their means, made possible by borrowed money. A White House economic advisor said that America is doomed to indebtedness because global investors give it the rope with which to hang itself.   Rich-world public debt is now 110% of rich-world GDP. The question is how much more can they borrow before the bubble bursts? In 2023, the average deficit of OECD countries was 4.6% of GDP, while America’s deficit was  6.1%. In the medium-term these are unsustainable percentages, as demonstrated by bond markets. Ten-year government bonds  now yield more in most large rich economies than they did when, in 2024, their central banks started cutting short-term interest rates. In short, bond investors sense danger.  Another danger they fear is inflation. After all, when debts increase, politicians may be inclined to pressure central banks to apply inflationary policies to lower the real value of debt.

 

Finance ministers of indebted rich countries anticipate higher expenditures. They are faced with ageing populations resulting in more pension and health care costs. They also face higher defence spending, greater costs from climate change,  and the prospect of rising interest rates. As for government’s income, i.e., taxes, politicians rather have one of their arms chopped off than raise taxes. At any event, taxes are already high in EU countries. In the US the political sentiment is not about tax increases but tax cuts.

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Not all rich countries have incurred unsustainable debts. Take Canada, as of the  1990s, the country applied a very strict fiscal policy, including privatisation of government businesses. Other frugal countries are in Scandinavia, Germany and the Netherlands. The four Tiger countries, Hong Kong, South Korea, Singapore and Taiwan, also belong to the ‘frugalist’ club. So, cutting down debt can be done. What are the possibilities be? One is a growing workforce. Increasing productivity is another.  As mentioned, inflation is yet another possibility. Finally, there is default.

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Countries with an ageing population may benefit from high-skilled immigrants to boost economic growth. Government debt will be spread over more inhabitants and deficits will decline as tax income  rises. But in the long run immigrants only delay but do not prevent the average age of the population from rising.

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It is hoped that AI may  result in productivity and economic growth. But is this justified? At any event, productivity growth should be higher than economic growth to make debt shrink. Exorbitant investments in AI make investors wonder  whether AI firms can pay back the loans, given anticipated small profit margins. Should AI replace workers on a large scale, unemployment outlays will increase and social cohesion may collapse.  

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Should economic growth increase, in countries with large welfare provisions not just incomes will rise but also pension and health care outlays. Economic theory says that interest rates will also rise. This will result in more expensive debt servicing  which might eat up the higher tax income resulting from growth.

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Promoting a bit of inflation to let the real value of debt shrink, is politically attractive but it may be dangerous. Inflation has the tendency to turn into hyperinflation, as we have seen happening during the late 1970s and early 1980s. It may well happen again, this time not in middle-income countries such as Mexico, Brazil and Argentina, but in rich countries not addressing their debt problem adequately.

Now, what are the likely measures that governments can take to prevent a debt crisis? Spending cuts are unlikely, given the ageing population and related higher health expenditures. Economic growth, propelled by AI, will have an upward effect on interest rates and may destabilase society’s social fabric. Tax rise is another possibility, but  a very hard sell for politicians of both sides of the political spectrum. What about inflation and default?   Regarding the latter, there is a taboo in rich countries on default.

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This leaves inflation as a solution. A combination of central banks buying bonds and at the same time, holding interest rates below the inflation rate, would result in shrinking debt in real terms. The Fed is under pressure from President Trump to lower its short-term interest rate. Apart from the president eroding the independence of the Fed, bond buying beyond what is strictly necessary will funnel inflation. This latter effect runs counter to one of the Fed’s central objectives: price stability (the other is full employment). In addition, inflation is unpopular among creditors, people depending on a fixed nominal income, as well as among real estate and bond holders. Inflation can run out of hand and then it is too late to stop it without doing much harm to the economy.

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It may well be that, even before a debt crisis breaks out, the AI bubble will burst and the ensuing financial crisis will force governments to take urgent measures to prevent a meltdown of their economies.

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Peter de Haan                                                                                                                                                                                                  December 2025