The financial crisis and accompanying recession have had a severe impact on government budgets, raising the specter of huge government debt burdens down the road. Large government debt burdens are not just a fiscal problem. They can become a monetary problem, since boosting inflation above the level embedded in the current interest rate on government debt is one way to trim the debt burden.
Recessions automatically trim tax revenues and pump up government expenditures for such things as unemployment benefits and other social needs. On top of these automatic effects, many governments have provided large dollops of aid to their financial sectors in response to the crisis and have undertaken substantial discretionary budget initiatives in an attempt to get economic activity rolling again.
The International Monetary Fund estimates that the financial crisis, the recession, and the associated fiscal initiatives will push the debt burden of the 10 largest developed countries from about 78 percent of GDP in 2007 to 106 percent of GDP in 2010, when a tentative economic recovery is likely. Moreover, under the IMF's most likely scenario, this debt burden will rise to 114 percent of GDP by 2014.
To reduce their debt burdens, advanced countries need to run substantial budget surpluses, but the prospect for quickly doing so are not good. While most economists anticipate that a recovery will begin before the year's end, many expect a long slog before economic growth returns to its potential rate. Automatic stabilizers will revert as economic growth heads back to its potential, but much of the fiscal expansion--especially in the United States-was discretionary. …