The 1980s was the decade in which high inflation was supposedly consigned to the dustbin of history, while the 1990s were all about the so-called new economy. The governor of the Bank of England, Mervyn King, called it the NICE decade (No Inflation, Continuing Expansion) – a time when the economy reached the promised land of high growth and price stability.

The following decade produced the worst financial and economic crisis in almost a century. The 2010s will be remembered as the decade of public debt. In the EU, for example, public debt in the most important countries may rise to 100% of gross domestic product (GDP) or more.

Something will be done, but doing enough will require reducing annual budget deficits by 0.5% of GDP every year just to make the average government debt more sustainable. That effect, however, has to come on top of withdrawing the fiscal stimulus provided by all countries. Fiscal consolidation equivalent to 1% of GDP per year might bring debt down toward 60% of GDP, the ceiling imposed by the EU’s stability and growth pact. But, in countries such as Greece, Ireland and Spain, this would not be enough to bring debt to a sustainable level by 2020.

Moreover, low long-term interest rates are a thing of the past. As deficits and public debt increase, the markets will demand higher risk premiums. So, public debt is not only set to increase much faster than nominal GDP growth, but governments will also have to devote an increasing share of revenues to interest payments.

Slashing expenditure and raising taxes will not really help, because these efforts will severely undermine performance. Greece’s total consolidation is set to increase to around 9% of GDP. The same goes for the United States, the UK and the eurozone’s five largest economies (Germany, France, Italy, Spain and the Netherlands).

Even if all these cuts are made, economic growth will turn out to be structurally much lower than the figures used now for estimating deficits and debt. The European Commission has stated that the GDP forecasts put forward in various governments’ budget plans are overly optimistic. Little wonder that the Commission has warned that crisis-related fiscal expansion and the ageing population raise questions about the sustainability of public finances in the EU.

Many governments behave as if the economic setback is temporary and happy pre-crisis days will return fairly soon. Among economists there is a strong feeling that the world economy is bouncing back and that the crisis is an aberration. But even if the world economy makes a firm recovery, the long-term trend has been severely and permanently disrupted. After this crisis, nothing in economics will be the same.

Indeed, it would be naïve to believe that the crisis is the only reason that public finances are in bad shape. Change in the global economy, from a decade of high structural growth to a period of low growth, is also playing a major role.

For the past 20 years, growth has been based on rising asset prices and declining costs of borrowing. That mechanism is broken beyond repair. Unless productivity improves miraculously, the world can expect a lengthy period of low growth and exceedingly difficult fiscal consolidation.

The NICE era is well and truly over. Welcome to the BAD (Big Annual Deficits) decade of public debt.

Sylvester Eijffinger is a professor of financial economics at Tilburg University in the Netherlands. Edin Mujagic is a monetary economist at ECR Research and Tilburg University. © Project Syndicate, 2010.

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