Debts, Deficits and Borrowing Costs

Extract

The recent downturn in economic activity has led to large-scale revisions to debt stock projections for all major economies. In this note we look at the projected evolution of debt stocks over the next decade, compare them to our pre-crisis projections from January 2008 and put uncertainty bounds around them. Increased debt stocks may increase the costs of borrowing by governments, and they appear to be a factor behind the increase in spreads on government bonds that we have observed in Europe in the past year or so. We analyse those spreads, and suggest that each excess rise of 34 per cent of GDP in government debt issued by members of EMU might, in the medium term, raise the cost of their borrowing by up to 100 basis points. We should be careful in extrapolating this to the UK situation, but there are lessons to be learnt.