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I want to understand the context of an article (Economist, Finance and Economics section, Oct 28th, 2022)

Bruno Le Maire, France's finance minister:

"Money is no longer interest-free in the new financial landscape. Rates on French ten-year government bonds, negative 18 months ago, have risen to more than 2.5%, which leads to billions of euros of additional fiscal expenditure. If European governments fail to anticipate higher debt-servicing costs, an inflationary crisis can suddenly become a financial one. Recent turbulence in British bond markets demonstrates the impact of a rapid rate surge."

Why would government's failure to anticipate higher debt-serving costs (rates on ten-year gov bonds) create a financial crisis?

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  • $\begingroup$ This references the turbulence in British bond markets which was caused by financial institutions failing to anticipate higher debt-servicing costs. I suppose the government could have told them to look out, but apart form that, blaming it on the government is a bit odd. $\endgroup$ Commented Nov 9, 2022 at 18:08

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Why would government's failure to anticipate higher debt-serving costs (rates on ten-year gov bonds) create a financial crisis?

Because many of the government expenses are in practice fixed. Government cannot very easily lower retirement benefits, healthcare benefits and other sort of spending. Of course technically they are changeable but politically its nearly impossible to do that.

As a result when government borrowing gets more expensive most governments can't just spend less. Consequently, they have to borrow even more to cover extra interest expense. Moreover, since the debt is constantly getting rolled over at some point even the old debt issued when interests were low will have to be replaced by higher interest debt. As the quote explains this creates a billions of extra expenditure for government.

A lot of government debt in most countries is held by the banking (or broader financial) sector. If government debt becomes too cumbersome to service country might eventually decide to default on its debt and because a lot of government debt is held by financial sector it can possibly also trigger financial crisis.

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    $\begingroup$ I think this is true but only on short time frames. At the scale of a couple of years there are many examples of countries making these adjustments. But these adjustments are painful, and many countries seem to choose default instead. $\endgroup$
    – BKay
    Commented Nov 9, 2022 at 14:32

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