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The Fiscal Cost of High Interest Rates

Graham Watson

3rd May 2024

Kenneth Rogoff writes an interesting piece here about the diminishing ability of government debt to help offer macroeconomic stability at a time of higher interest rates.

The latest IMF research asserts that the rising levels of debt in developed economies now represents a drag on growth, as it rises to an average 120% of debt-to-income in advanced economies.

Whilst developed economies rarely default on debt, the opportunity cost of higher debt repayment will limit the ability of fiscal policy to help governments achieve their macroeconomic objectives.

The moribund state of the UK economy is expected to extend into 2025, with the OECD forecasting UK growth of 1.0%, after 0.4% growth this year. It's believed that interest rates are going to stay higher for longer, meaning that of the G7 nations, only Germany is forecast to experience lower growth.

The Federal Reserve has stayed its hand, keeping interest rates unchanged at 5.25% to 5.5% because of a lack of progress towards reaching the inflation target. US inflation is currently 3.5% and has been stubborn in falling any further, so the Federal Reserve are cautious.

And what the Fed does, other central banks generally follow - Bagpuss economics, if you will - meaning that interest rates in the Eurozone and the UK might stay higher for longer too.

Graham Watson

Graham Watson has taught Economics for over twenty years. He contributes to tutor2u, reads voraciously and is interested in all aspects of Teaching and Learning.

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