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Government deficits to soar to wartime levels

Budget deficits in advanced economies in 2020 are set to rise enormously because of the impact of the coronavirus and the policies deployed to tackle it.Our latest forecasts for the US and UK see general government deficits in Q2 of 20%-25% of GDP – a scale not seen since World War II. Even with a strong economic rebound from Q3, deficits for the full year will reach 11%-15% of GDP.Deficits will soar due to lower revenues from weaker activity and the high cost of policies to preserve firms and employment. If lockdowns last longer than we expect, the fiscal costs will mount rapidly.Most advanced economies should be able to finance these deficits cheaply, helped by massive QE. But economies without monetary independence or with low tolerance for higher deficits will find borrowing on this scale hard.Government debt levels will rise by 10%-20% of GDP by 2021 in most advanced economies. Debt ratios will remain below or comparable to those seen after WWII and, given low borrowing costs, should not be destabilising. But weaker sovereign issuers such as Italy could face problems.In the global financial crisis, extra fiscal costs accrued from bank bailouts. Bank finances are generally in better shape now, but the scale and speed of the downturn could still prove problematic for weaker banking systems.A long-term fiscal risk is that the private sector boosts savings and cuts spending after the virus comes under control. As in Japan’s case in the 1990s and 2000s, this would risk deficits staying high for an extended period.

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