The Bank for International Settlements (BIS) has sounded a stark warning to governments worldwide: the relentless buildup of public debt is no longer sustainable now that the era of ultra-low interest rates is over. In a speech delivered at a central banking conference in Tokyo, BIS General Manager Agustín Carstens cautioned that countries which have relied on cheap financing to support large deficits must act swiftly to restore fiscal health. Otherwise, rapidly rising borrowing costs and growing imbalances could trigger a sudden loss of market confidence, destabilize financial systems, and undermine economic stability.

From “Free Money” to Painful Borrowing

Over the past decade, many governments took advantage of near-zero interest rates to run sizeable budget deficits without confronting politically difficult choices such as reducing public spending or increasing taxes. Stimulus packages launched in the aftermath of the global financial crisis and during the COVID-19 pandemic pushed debt‐to‐GDP ratios in advanced economies well above 100 percent, and in some emerging markets beyond 60 percent. Low borrowing costs allowed this expansion of spending to go largely unnoticed by financial markets.

However, those days of virtually free money are receding. Central banks from the United States to Europe to Japan have begun raising policy rates to counter persistent inflationary pressures, causing yields on government bonds to climb. As borrowing costs rise, the sheer scale of accumulated debt means that budgetary trajectories for many nations have grown precarious. Carstens warned that fiscal participants have only a narrow window to “put their house in order” before markets reevaluate sovereign creditworthiness, potentially causing bond yields to spike further and turn comfortable financing into an immediate crisis.

Unsustainable Paths: Market Signals and Fiscal Imbalances

Recent months have seen a steady uptick in long‐term government bond yields in the United States, Europe and Japan. In the U.S., the 10-year Treasury yield has moved above 4 percent for the first time in over a decade, while benchmark German bunds and Japanese government bonds have climbed from historically low levels. These shifts partly reflect the market’s anticipation that governments will maintain or increase fiscal deficits even as borrowing costs climb. Investors are now growing more sensitive to the gap between expected future spending commitments—such as pensions, healthcare, and infrastructure projects—and actual revenue streams.

Carstens pointed out that the combination of large structural deficits and elevated debt ratios has left some countries with fiscal paths that markets may deem unsustainable. He emphasized that sudden swings in investor sentiment can occur, possibly leading to abrupt corrections in government bond markets. A rapid surge in yields would not only increase debt servicing costs but could push some governments into “fiscal dominance,” whereby central banks are compelled to monetize debt instead of focusing on price stability. The result, he warned, would likely be higher inflation and sharp exchange‐rate swings, eroding public trust and hampering economic growth.

Risks to Monetary Policy and Global Financial Stability

One of Carstens’ core messages was that fiscal slippage cannot be left entirely in the hands of central banks to resolve. If policymakers continue to rely on monetary support to keep interest rates artificially low—and by extension, ease government borrowing—central banks may lose the capacity to fulfill their primary mandate of price stability. In an environment where inflation drivers include supply‐side factors and geopolitical disruptions, he argued, central banks cannot be expected to “stabilize inflation at very short horizons and within narrow ranges.” Overburdening monetary policy with fiscal propping stifles flexibility and risks eroding the credibility of central banks. Furthermore, prolonged periods of lax fiscal discipline risk entrenching public expectations of inflation, making it harder to rein in price pressures without triggering outright recession.

Carstens also underscored the threat public‐debt distress poses to the global financial system. Should a major sovereign face a sudden spike in bond yields, banks and institutional investors holding large portfolios of government bonds would see the market value of their assets plunge. This “crowded trade” dynamic could induce liquidity strains in critical funding markets and produce contagion across sectors. In extreme cases, a sovereign default or forced restructuring could reverberate through international financial markets, upending cross‐border banking relationships and exposing global banks to losses that threaten broader monetary and financial stability.

Structural Pressures: Ageing Populations, Climate Commitments, and Defense Needs

While emphasizing that immediate consolidation is essential, Carstens acknowledged that governments will confront mounting pressures over the medium term. An aging population in advanced economies is already placing upward pressure on pension and healthcare obligations. In countries such as Japan and many in Western Europe, the proportion of citizens over the age of 65 has risen sharply, demanding larger transfers and social spending even as the ratio of working‐age individuals shrinks. These demographic headwinds will constrain budgetary flexibility, making it even more difficult to pare back deficits without structural reforms to entitlement programs.

Climate change mitigation and adaptation commitments also loom large on fiscal balance sheets. Governments are pursuing net‐zero transition plans that involve subsidizing renewable energy, electrification of transport, energy‐efficiency upgrades, and disaster preparedness measures. While these investments yield long‐term economic and social benefits, they come with steep upfront costs. The imperative to invest in green infrastructure often collides with the need to keep deficits in check. Carstens stressed that clear, transparent financing plans are needed for climate initiatives, rather than allowing expenditures to inflate existing deficits unpredictably.

In addition, geopolitical tensions have triggered renewed calls for higher defense spending. In response to Russia’s invasion of Ukraine and growing U.S.–China strategic competition, many European nations and allies in Asia have committed to raising their military budgets. The reallocation of resources to defense further stretches already strained public finances. Masking these outlays as temporary without sustainable financing or offsetting revenue measures risks compounding deficits and sowing the seeds of future debt crises.

Need for Credible Fiscal Frameworks and Policy Transparency

A central element of the BIS’s prescription is that fiscal authorities must establish transparent, credible paths to fiscal sustainability—backed by concrete measures rather than aspirational targets alone. Carstens argued that countries need to strengthen multi‐year budget frameworks, introduce binding fiscal rules, and design institutional checks on borrowing. A credible framework sends a clear signal to markets that a government will honor spending and revenue commitments, reducing the risk premium attached to its borrowing. For instance, adopting debt‐to‐GDP targets in law, or independent fiscal councils to monitor compliance, can demonstrate that policy decisions are not solely politically motivated but align with long‐term sustainability.

In practical terms, this could involve phasing out untargeted subsidies, broadening tax bases to reduce reliance on unsustainable sources, and reforming entitlement programs to better calibrate benefits with demographic realities. Governments might explore property or environmental taxes, targeted consumption levies, or carbon pricing mechanisms that generate revenue while advancing climate goals. Some have called for reevaluating the progressivity of income taxes or introducing wealth taxes to capture a fairer share from high‐net‐worth individuals. On the expenditure side, better prioritization of spending, rigorous cost‐benefit analyses for large projects, and enhanced transparency in procurement can help curtail waste and ensure that each dollar spent delivers maximum public value.

Carstens acknowledged that some degree of fiscal support may still be needed to bolster economic growth, especially in emerging markets grappling with weaker growth prospects. However, he cautioned that such stimulus must be “well targeted, temporary, and accompanied by clear exit strategies.” In other words, fiscal interventions should be designed to boost demand or finance critical investments in areas like infrastructure or social safety nets—but only with well‐defined sunset clauses and offsetting measures to avoid adding permanently to the debt stock.

For example, rather than extending across‐the‐board tax cuts or permanent benefit expansions, governments could implement time‐bound relief for low‐income households or sectors most affected by economic slowdowns. Infrastructure projects should be prioritized based on readiness and returns, favoring investments that support productivity growth—such as digital connectivity, green energy grids, and transportation links—over those with uncertain economic payoff. Carstens emphasized that muddling through with indefinite “stimulus for stimulus’s sake” risks embedding higher debt without unlocking sustainable growth.

Diverse Country Challenges

The BIS has highlighted that advanced economies, having already financed record debt loads during the pandemic, will need to begin consolidating now to avoid snowballing debt servicing costs. In the United States, for instance, the Congressional Budget Office projects federal debt held by the public will rise from about 100 percent of GDP in 2023 to nearly 120 percent by 2034, driven by entitlement spending, rising interest costs, and sizable deficits. Without fiscal adjustments—either in the form of revenue increases or spending cuts—interest payments on the debt alone could outstrip defense budgets within a decade. Moreover, stabilizing debt at current levels would require immediate, permanent fiscal improvements amounting to more than 3 percent of GDP annually—a politically formidable task.

In the euro area, governments in France, Italy and Spain have similarly seen debt‐to‐GDP ratios soar above 110 percent, while the European Central Bank’s shift away from bond‐purchasing has contributed to higher sovereign yields. Italy, which carries one of the highest debt burdens in the region, now faces an acute dilemma: communicate credible deficit‐reduction plans to reassure investors, or risk a sharp rise in bond spreads that could ultimately force the European Central Bank into renewed emergency interventions. Meanwhile, Japan’s debt ratio has hovered near 260 percent of GDP for years—a legacy of decades of fiscal stimulus and deflationary pressures—but its debt carries extremely low interest costs due to domestic savings. Still, even in Tokyo, bond yields have edged upward as global rates rise, and any loss of credibility in debt management could have outsized ripple effects on the economy’s fragile equilibrium.

Emerging markets confront their own version of debt strain. In Latin America, several nations rely heavily on commodity exports; when global prices falter, fiscal deficits widen abruptly, prompting a scramble for external financing. Countries like Argentina and Ecuador have already defaulted multiple times this century. Others—such as Brazil and Mexico—are working to gradually reduce deficits, but face social pressures to fund healthcare, pensions and security. In Asia, Indonesia and India must balance infrastructure spending with the need to contain burgeoning debt ratios, lest they jeopardize their sovereign credit ratings and disrupt capital inflows. In all these cases, the pressing question remains: Can governments restructure spending and revenue frameworks before markets lose patience and force more draconian adjustments?

A Call to Action: Fiscal Consolidation Starts Now

The BIS’s message is blunt: fiscal reckoning cannot be indefinitely postponed when interest rates are low. With policy rates rising and inflationary pressures simmering globally—partly driven by supply‐chain disruptions, geopolitical strife, and climate-related shocks—governments have a narrow window to institute credible, long‐term fiscal strategies. Waiting for a crisis to force painful retrenchment is a recipe for instability, Carstens warned. Instead, proactive fiscal consolidation—rooted in transparent frameworks, targeted reforms, and realistic growth assumptions—offers the best chance to preserve financial market confidence and sustain economic expansion.

In closing, the BIS chief affirmed that enduring fiscal sustainability requires a partnership between governments and central banks. While monetary policy has played a crucial role in navigating past downturns, it cannot indefinitely compensate for unchecked fiscal deficits. Ultimately, restoring a healthier balance between government budgets and debt levels is not just a technical exercise—it is a prerequisite for upholding public trust, ensuring long‐term prosperity, and safeguarding global monetary stability in an increasingly uncertain world.

(Adapted from FastBull.com)

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