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Is Europe’s economic stagnation the result of insufficient Keynesian stimulus, or are its bloated and sclerotic welfare states to blame? Either way, it is clear that those who believe simple measures like higher budget deficits or lower interest rates can solve Europe’s problems are detached from reality. For example, France’s aggressive stimulus policies have already pushed its budget deficit to 6% of GDP, while its debt-to-GDP ratio has surged to 112%, up from 95% in 2015. In 2023, President Emmanuel Macron faced widespread protests over his decision to raise the retirement age from 62 to 64 – a move that, while meaningful, barely scratches the surface of the country’s fiscal challenges. As European Central Bank President Christine Lagarde recently warned, France’s fiscal trajectory is unsustainable without far-reaching reforms. Many American and British progressives admire France’s model of big government and wish their own countries would adopt similar policies. But debt markets have recently woken up to the risks posed by France’s ballooning debt. Remarkably, the French government now pays a higher risk premium than Spain.
With real interest rates on advanced-economy government debt expected to remain elevated – barring a recession – France cannot simply grow its way out of its debt and pension problems. Instead, its heavy debt burden will almost certainly weigh on its long-term economic prospects. In 2010 and 2012, Carmen M. Reinhart and I published two papers arguing that excessive debt is detrimental to economic growth. The sluggish, indebted economies of Europe and Japan are prime examples of this dynamic, as subsequent academic research has shown.
Heavy debt burdens impede GDP growth by limiting governments’ ability to respond to slowdowns and recessions. With a debt-to-GDP ratio of just 63%, Germany has ample room to revitalize its crumbling infrastructure and improve its underperforming education system. If implemented effectively, such investments could generate enough long-term growth to offset their costs. But fiscal space is valuable only when used wisely: in reality, Germany’s “debt brake” – which caps annual deficits at 0.35% of GDP – has proven too inflexible, and the next government must find a way to work around it.
As Europe prepares for a potential trade war after US President-elect Donald Trump takes office in January, its two largest economies are struggling. While Germany is heading into its second consecutive year of zero growth, France is expected to grow by less than 1% in 2025.