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Thursday, June 2, 2011

Sovereign Debt in Advanced Economies: Overview and Issues for Congress

Rebecca M. Nelson
Analyst in International Trade and Finance

Sovereign debt, also called public debt or government debt, refers to debt incurred by governments. Since the global financial crisis of 2008-2009, public debt in advanced economies has increased substantially. A number of factors related to the financial crisis have fueled the increase, including fiscal stimulus packages, the nationalization of private-sector debt, and lower tax revenue. Even if economic growth reverses some of these trends, such as by boosting tax receipts and reducing spending on government programs, aging populations in advanced economies are expected to strain government debt levels in coming years.

High public debt levels became unsustainable in three Eurozone countries: Greece, Ireland, and Portugal. These countries turned to the International Monetary Fund (IMF) and other European governments for financial assistance in order to avoid defaulting on their loans. Japan’s credit rating was downgraded by a major credit rating agency, Standard and Poor’s (S&P), in January 2011 over concerns about debt levels. In April 2011, S&P put the United States’ credit rating on a negative outlook, although the rating itself was not changed. Distress about high levels of debt in advanced economies is a major shift; in recent decades, emerging markets were the center of concerns about sovereign debt crises (e.g., the 1980s Latin American debt crisis and Russia’s financial crisis in 1998).

To date, many advanced-economy governments have embarked on fiscal austerity programs (such as cutting spending or increasing taxes) to address historically high levels of debt. This policy response has been criticized by some economists as possibly undermining a weak recovery from the global financial crisis. Others argue that the austerity plans do not go far enough, and do not share the burden of adjustment with creditors who, they argue, engaged in reckless lending. 

Issues for Congress

  • Is the United States headed for a Eurozone-style debt crisis? Some economists and Members of Congress fear that, given historically high levels of U.S. public debt, the United States is headed towards a debt crisis similar to those experienced by some Eurozone countries. Others argue that important differences between the United States and Eurozone economies, such as growth rates, borrowing rates, and type of exchange rate (floating or fixed), put the United States in a much stronger position. The United States has a strong historical record of repayment, and bond spreads indicate that investors do not currently view the United States in a similar light to Greece, Ireland, or Portugal. 
  • Impact on U.S. economy. How other advanced economies address their debt levels has implications for the U.S. economy. Currently, most advanced economies are focused on austerity programs to lower debt levels. This could slow growth in advanced economies and, because they are among the United States’ main trading partners, depress demand for U.S. exports. If advanced economies shift to restructuring debt, U.S. creditors exposed overseas could face losses on their investments. U.S. bank exposure to Greece, Ireland, and Portugal in general (not just to governments) is less than 3% of total U.S. bank exposure overseas.
  • Policy options for Congress. Congress is currently debating proposals to reduce the federal debt. Multilaterally, Congress could urge the Administration to coordinate fiscal policies to avoid simultaneous austerity reforms that undermine the economic recovery.

Date of Report: May 26, 2011
Number of Pages: 36
Order Number: R41838
Price: $29.95

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