On the Road to a French Sovereign Debt Crisis | American Enterprise Institute
France’s compromised public finances might not be quite as bad as those of the United States and Japan. However, there are two reasons to think that France could experience a sovereign debt crisis before those two other countries. The first is that France is scheduled to have a presidential election next April that could materially worsen the country’s public finance outlook. The second is that France is stuck in a Euro straitjacket that highly complicates the task of correcting the country’s public finances even if there was the political will to do so.
Start with the forthcoming presidential election. At a time, when the country is running a 5 percent of GDP budget deficit and when its debt to GDP ratio is already above 110 percent of GDP, its two leading presidential candidates for the forthcoming election, Marine Le Pen and Jean-Luc Melonchon, are not known for their support for budget austerity.
While the front runner Ms. Le Pen of the right-wing National Rally Party does recognize the need for budget deficit reduction, her actual legislative record has been that of opposing nearly every concrete deficit reduction proposal put forward by the current government. She has argued that those proposals place too great a burden on ordinary households. To date, she has been rather vague about how she would cut the budget deficit and is yet to produce a coherent budget deficit reduction program. Her critics have questioned whether her proposals to cut spending on immigrants and welfare would make much of a dent in the country’s budget deficit.
Very much more troubling are the budget proposals of Mr. Melonchon, the Socialist Party candidate. He has revived a call for the European Central Bank to “freeze” state debts, starting with those from the Covid period, and is pushing to cancel roughly a fifth of French public debt, the portion held by the Banque de France. He argues the move would cost nobody anything and have no real economic or financial impact, calling it just an accounting entry on the central bank’s balance sheet. At the same time, he is pushing for an increase in social spending even when France’s public spending is already at around 58 percent of GDP.
All of this makes it likely that in the second round of France’s presidential election, we will have two candidates who will be campaigning on platforms not conducive to budget deficit reduction. It is also likely that the election will take place against the backdrop of continued sclerotic economic growth as the French economy will have to contend with an energy price shock, higher interest rates, and increased competition from Chinese exports redirected away from the US market. This will likely prevent the current government from taking any realistic budget deficit reduction measures before the election, and campaign promises will likely cloud the post-election budget outlook.
Unlike the United States and Japan, as a Eurozone member country, France has the disadvantage of not having its own currency. As such, it cannot engage in interest rate cuts or exchange rate depreciation to offset the contractionary impact on aggregate demand of budget policy belt tightening. So even if France had the political willingness to undertake budget austerity, that austerity would risk tipping the country into recession.
During the 2010 Eurozone sovereign debt crisis, we saw that a debt crisis in even a small country like Greece could spread quickly to the rest of the Eurozone’s economic periphery. Today, there is the risk that a debt crisis in France, the Eurozone’s second largest economy, could spread to the United States and Japan that have even more compromised public finances than does France. The recent spike in the 10-year French government bond yield to 4.1 percent, or its highest level since 2010, suggests that the French economy in the runup to next year’s presidential election bears close monitoring.
