European countries are shelling out huge sums to deal with the energy crunch. Economists fear it could spark a new financial crisis.
A new debt crisis could be looming as European countries throw huge sums of money at the energy crisis.
"I believe several will struggle to avoid debt problems in the coming years and the result will be painful," a Stanford economist told Insider.
That could cause rates to stay higher for longer or trigger a sharp change in policy to stabilize the economy.
Europe is facing a macroeconomic storm. Amid an energy crisis, sky-high inflation, and a possible recession, some experts think a new debt crisis could be looming for some European nations as governments ramp up spending to shield consumers from soaring energy costs.
The crisis has largely stemmed from Russia slashing gas supplies to the continent, which has driven up energy prices and forced governments to swoop in with tax cuts, price controls, consumer subsidies, and other measures to alleviate pain – all while balancing hefty amounts of debt.
The UK, whose debt accounted for 143% of its GDP last year, has shelled out the equivalent of 178 billion euros battling the energy crisis so far – the most out of any country in Europe, according to data from think tank Bruegel. France, whose debt accounted for 145% of its GDP last year, has earmarked 71 billion euros, and Germany, whose debt is 77% of its GDP, doled out 100 billion euros before approving another 200 billion euro aid package.
Much of that spending is being funded by more government borrowing. But the challenge of paying those debts back down the road is where trouble arises, according to Michael Boskin, an economist at Stanford University.
"I believe several will struggle to avoid debt problems in the coming years and the result will be painful," Boskin told Insider. "And it's historically been the case that heavily indebted countries wind up having problems. They might have a financial crisis, they might stoke inflation. It might and often does result in slow growth over the longer term."
While each country's debt situation is unique, Boskin notes spending is a major concern as a whole for Europe: Southern European countries, like Greece, have historically run higher debt and deficits levels than northern European countries. But, northern European countries are facing a colder winter, which means they're at risk of having to shell out the most money to keep their citizens secure, with diminished energy supplies flowing to the continent.
Already, the energy crisis is estimated to have cost Europe around 700 billion euros. That can bring further weakness to European economies for three reasons, Boskin says:
Inflation has already shocked the continent. Eurozone inflation clocked in at 10% in September. Combined with a high debt load, that spells trouble, Boskin says, because debt itself is also inflationary.
Some countries are dealing with weakness in their banking systems. He pointed to Italy as one example, where banks have needed help from the government. Additional spending and debt from the energy crisis could result in more stress being exerted on the financial system.
Some nations are dealing with political tensions. Boskin pointed to the Maastricht Treaty, which establishes a 3% budget deficit ceiling for EU countries, and a no-more-than-60% rule for the government debt to GDP ratio. Raising those requirements to accommodate for additional spending could set off more political turmoil.
"Throwing the energy shock on top of that is a big economic stress. If something else should go wrong, there aren't any shock absorbers left." he said.
Is a crisis looming?
The way through the macro storm isn't entirely clear, and the answer isn't necessarily to slam the brakes on government spending to alleviate the energy crisis, according to Jennifer Lee, an economist at the Bank of Montreal.
"I think a debt crisis could very likely ensue given the vast amounts that [are] being spent as a percentage of GDP. It is necessary though, much like pandemic spending, but will add to the high pile of debt that has already been accumulating," Lee said.
Other experts believe that the probability of a debt crisis is low, and the priority should be to alleviate the pain of high energy prices, which has been the main driver behind eurozone inflation, according to Eurostat.
"Inflation is the massive threat," David Wech, Vortexa's chief economist told Insider. He pointed to recent declines in gasoline consumption, a sign that inflation has already been hammering away at economic activity. Gasoline imports to the Atlantic Basin, which includes Europe, fell 15% month over month in September, four times the usual seasonal decline.
"Helping consumers and enterprises to cope with much more drastically rising electricity prices is essential to moderate the impact on economic activity … The bigger risk is high prices and inflation. I personally think [a debt crisis] is a minor concern," he said.
And in the event high debt loads do push Europe to a critical point, the outcome may not be a financial crisis, Boskin notes, although it could trigger a swift change to government spending or taxes in some countries.
"No one can predict exactly when [but] the gradual pain adds up to something that is substantial and there has to be an abrupt change at some point," he said.
What is certain though is that rates will be higher for longer than expected – to the tune of 12-18 months rather than six to 12 months, Boskin noted. He estimated that if the ECB raises the policy rate above 4%, it could be "very painful" to households, particularly to homes that have borrowed with floating rate mortgages. And if inflation soars even higher for a prolonged period, the monetary policy required to stabilize the economy could be even more disruptive.
"I do not think it's unavoidable. But once you're aware the risks are out there, it would be far less risky to address the underlying causes soon," Boskin warned.
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