Stéphane Colliac: Hello, everyone, and welcome to this new episode of Microwave, the podcast from BNP Paribas Economic Research. Today, we're looking at public finances in advanced economies. Between rising interest rates, aging populations and the needs associated with climate change and defence spending, the budget equation is becoming increasingly tricky, with the risk of seeing public debt increase. I'm Stéphane Colliac, Head of the Advanced Economies team at BNP Paribas Economic Research, and I'm joined by my colleague Marianne Mueller, European economist, and Benjamin Puiseux, intern economist within the team.
Benjamin Puiseux: Hello
Marianne Mueller: Hello, and thank you, Stéphane, for setting the scene. Let's start with the main observation. Can you describe the current state of public finances in advanced economies?
Stéphane Colliac: Public deficits remain high, particularly in the United States, France and the United Kingdom. However, while the latter two are engaged in fiscal consolidation, this remains marginal in the United States. The situation is different in Spain and Italy, where fiscal consolidation is much more advanced. Germany and Japan, on the other hand, are likely to see their public deficits increase.
Marianne Mueller: What is the current state of public debt and how is it likely to evolve?
Stéphane: Public debt has increased and will continue to increase in countries that account for nearly 80% of global GDP, according to the IMF. While public debt is increasing, it is primarily due to public deficits. Therefore, it is not surprising to find the United States, France and the United Kingdom on the list of countries whose debt will continue to grow between now and the end of the decade. Conversely, more modest deficits will enable Spain and Italy to reduce their public debt.
Benjamin Puiseux: Marianne, let’s talk about Germany now. What can you tell us about it?
Marianne Mueller: In Germany, public debt there will increase by nearly 7 points between its 2024 level and what we anticipate for 2030, as the public deficit will grow significantly between 2025 and 2027 in order to finance in defence and infrastructure investment plans. However, it should be noted that we are talking about debt levels that are and will remain limited, and a time-conrtrainted deficit increase. This is because the German authorities are expected to bring their public deficit back to the 3% of GDP needed to stabilise debt by the end of the decade.
Stéphane Colliac: Benjamin. We regularly hear that rising interest rates complicate the management of public finances and, in particular, contribute to an increase in debt. How so?
Benjamin Puiseux: It is important to understand that the evolution of public debt in the coming years is a consequence of the current state of public finances. We have just talked about the deficit. Interest rates are another important factor. For more than ten years, advanced countries benefited from very low rates, which, incidentally, made it easier to manage debt after the COVID crisis, but the situation has changed. First, inflation rose and rates followed, but less than inflation, and it was when inflation moderated, starting in 2024, that the rise in nominal interest rates began to bear down, because that was when real interest rates began to rebound. When real interest rates rise, the budget equation becomes trickier.
Stéphane Colliac: What can we expect in the coming years?
Benjamin Puiseux: understand that the full effect of the rise in rates has not yet been felt. Thanks to the long maturity of debt, the average real interest rate that governments pay on their debt, also known as the apparent rate, remains well below the interest rate currently observed on the markets and, even more so, below GDP growth.
Stéphane Colliac: Does this comparison between interest rates and growth affect the evolution of public debt?
Benjamin Puiseux: What matters is the comparison between the real apparent interest rate, called r, and the real growth rate, g. When r is lower than g, a country can both maintain a moderate deficit and reduce its public debt. When r approaches or exceeds g, primary surpluses (by “primary”, we mean excluding interest charges) must be generated, otherwise public debt will increase.
Stéphane Colliac: Marianne, how are the different countries positioned?
Marianne Mueller: They’re not starting from the same point. Italy is already being forced to generate primary surpluses. The United States may have to follow the same path, due to the short average maturity (around six years) of its debt, which means that rate increases are quickly passed on to most of the debt to be repaid. In other countries, r should catch up with g by the end of the decade. Germany and Japan are special cases: they are the countries that have benefited most from negative rates. In these countries, the convergence of r towards g is expected to only occur in the next decade.
Benjamin Puiseux: Let's now talk about another issue that is already affecting public finances. I'm referring to aging populations. Marianne, can you describe the main effects of this for us?
Healthcare and pension spending is increasing in all advanced economies. In the United States, it is expected to reach 11.2% of GDP in 2050, compared to 8.3% today. The situation is even more striking in Japan, where pensions and healthcare will account for nearly 23% of GDP in 2040.
At the same time, the ratio of working people to retirees has fallen sharply. It is already less than two in countries such as Japan, Italy, Germany and France, and it is expected to continue to deteriorate.
Benjamin Puiseux: Do governments have levers at their disposal to enable public finances to better absorb this impact? Stéphane, can you give us an example?
Stéphane Colliac: One of the levers for limiting the impact of aging populations on social spending is employment rate of older citizens. Several countries have undertaken reforms aimed at raising the retirement age or encouraging people to continue working after retirement, as has recently been announced in Germany. This is a crucial lever. In France, for example, if the employment rate for 55–64 year olds simply reached the European average, it would improve the public deficit by nearly 0.8% of GDP per year.
Benjamin Puiseux: The other major constraint currently being discussed is defence. We are seeing a real paradigm shift here.
Marianne Mueller: Europe has committed to increasing its defence spending to 3.5% of GDP by the end of the decade, compared with around 1.9% in 2024. For France, this accounts for around +0.2 percentage points of GDP per year until 2030. For Germany, this effort is aided by lower debt, but for countries such as Italy and France, there is less room for manoeuvre. However, it is clear that in most countries, the difference between what is spent on defence today and what will be spent at the end of the decade accounts for between 1 and 1.5 points of GDP, a margin of manoeuvre that will need to be found. If not, public debt will increase by the same amount.
Benjamin Puiseux: Stéphane, given that spending is set to increase for all of the reasons that we have just mentioned, won't growth be a decisive factor?
Stéphane Colliac: Yes, as we have said, limiting fiscal deficits is a decisive pre-condition to stabilise public debt, and rising interest rates complicate the situation. In addition, of course, all of this would be further complicated if these risks materialize on growth. This is a frequently held view. However, let's not forget to consider the opposite scenario, because, at the moment, growth is actually accelerating in the United States and the Euro area, and our calculations show that 0.5 percentage points of growth, either above or below target, would be enough to change the trajectory of debt between now and 2030.
Benjamin: How so?
Stéphane Colliac: Well, first of all, some of the spending is having an impact on growth, particularly the European rearmament plan, and we are among those who believe that this effect will be pronounced, particularly in Germany. Secondly, all countries are investing in artificial intelligence. This is a massive investment effort and, based on the experience of the United States, which is always a little ahead of the developments that we will then see in Europe, it generates significant productivity gains. This is precisely the type of shock that could have a significant impact on growth, both reducing public deficits and enabling g to once again exceed r. Such developments would stabilise public debt much earlier, as early as 2028 in France or Germany, for example.
Marianne Mueller: To sum up, public finances have to contend with many issues, including new spending priorities (such as rearmament), aging populations and rising interest rates. Therefore, it will be more difficult than before to contain public debt. Clear choices will have to be made, such as defining spending priorities, choosing which reforms to implement and identifying the growth levers to focus on. The longer that the consolidation of public finances is delayed, the greater that the deficit reduction effort required to stabilise debt will be. Thank you very much, Stéphane and Benjamin, for these insights.
Stéphane and Benjamin: Thank you.
If you would like to learn more, I would recommend reading the latest issue of our EcoPerspectives on advanced economies, as well as our EcoCharts on public finances in advanced economies, both available on the BNP Paribas Economic Research website. Thank you for your attention and see you soon for a new edition of Microwave.
