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A government’s dilemma: debt or depression?

Published on 28/01/2009

Paris -- To spend, or not to spend is the question on many governments’ minds right now.  

Governments’ bold moves to spend their way out of recession are swelling their already big debt burdens, economists warn, but in the short-term, some may have no choice but to go deeper into the hole.

Seized by the financial and economic crisis that spread worldwide last year, the United States and European governments have begun to pour money back into their economies with massive rescue packages.

Economic stimulus measures in the United States have so far pushed its public debt to between 65 and 70 percent of its gross domestic product (GDP).

In early 2008, after the devastating US credit crisis erupted, former American president George W. Bush launched a stimulus package of 168 billion dollars. As the trouble deepened late last year, he agreed to a 700 billion dollar (547 billion euros) bailout for the country’s banks.

Now, the new American president, Barack Obama, is planning another massive package of 825 billion dollars in tax cuts and investments.

However, for some experts, even this new plan is not enough. "Mr. Obama needs to make his plan bigger," wrote the Nobel Prize-winning economist Paul Krugman in the New York Times. "My advice to the Obama team is to scrap the business tax cuts, and, more important, to deal with the threat of doing too little by doing more."

The United States does "have the means to borrow more," said Marcos Poplawski-Ribeiro, an economist at France’s CEPII economic research institute. "The question is whether that’s advisable. Whether the benefit of greater indebtedness is worth the effort."

German authorities wrapped up a 50 billion euro stimulus package last week, which includes a huge increase in public spending and tax cuts. Last year, it launched a 480 billion euro rescue for its stricken banks.

France unveiled its own 26 billion euro stimulus effort in December and Britain unveiled a second multi-billion-pound bank rescue package on Monday, which aimed at kick starting its stalled economy.

Yet, according to Poplawski-Ribeiro, these measures will “not be sufficient to bring growth back to its level before the crisis." European countries "have no more money to spend," he added.

Heavy borrowing by European governments has sparked concern that strains on bond markets could break up the bloc, prompting vigorous denials by European officials.

Concerns about weaker countries in the euro zone have driven the spread, or difference, between interest rates on debt issued by high-deficit member states compared to a key reference point, low-risk German government bonds, to record levels.

The higher interest that indebted countries pay reflects the higher risk of default by these members.

Officials have been compelled to deny talk that this strain could tear the euro zone apart, while also insisting on the need for governments to keep deficits and debt under control.

Amid concern over anti-recession borrowing by governments, Portugal became the third country in the euro zone, after Spain and Greece, to have its sovereign debt rating lowered by the agency Standard and Poor’s on Wednesday.

The ratings agency has also warned that Ireland is in the danger zone. A downgrade drives up the cost of borrowing for a government needing to fund a budget deficit.

"There are speculators who are playing on the possibility that the euro zone will fall apart," said Elie Cohen, research director at France’s scientific research centre CNRS. "That’s absurd because it’s in no one’s interests to see countries leave the euro."

One of Europe’s problems, however, is its lack of a "collective plan to help weak countries whose capacity to go into debt will be hindered," Cohen added.

Europe does have room to go deeper in debt, Cohen says, but it needs to plan ahead. "After the crisis, states will have to launch a policy of massive debt reduction."

Veronique Dupont/AFP/Expatica