Economic Survey 2-2010

Financial turbulence has again characterised the global economy this spring. In a number of countries, particularly in southern Europe, measures to counteract the financial crisis and eff ects of automatic stabilisers have weakened the budget balance so much that financial market participants fear defaults on government debt. Market participants perceive government debt as risky, also in countries where the debt is not so large. The rising yield on government bonds is compelling many countries to tighten fiscal policy earlier than the cyclical situation would imply. Thus the financial crisis has become a government level financial crisis. Because of the higher yields on bonds, reducing government debt is more demanding now than it was in the past. If economic growth picks up in the period ahead, it will help to moderate the debt burden. On the other hand, budget cuts may curb growth in the short term, and the events of the last couple of years may have permanently reduced the growth potential in the OECD area. The risk of defaults on government debt has aroused fear of major losses in banks that own this debt, which may lead to a restrictive lending policy among banks and to the public. At worst, we may be heading into a new financial crisis.