Public debt in the major advanced economies is now as high, as a share of GDP, as it was after the Second World War, when high military spending had been financed by borrowing. (See Chart: Government bond yields.) In late autumn 2009, fears arose in financial markets that some countries would be unable to pay their debts. The unrest was triggered when Greece announced that its public finances  BIS Review 123/2010  1  were in poor shape. Government bond yields rose markedly in Greece, Spain, Portugal and subsequently Ireland compared with German bond yields. Sovereign credit ratings were downgraded and the price of insurance against sovereign debt default soared. (See Chart: Credit risk on sovereign debt.) Sovereign debt has been regarded as the safest form of investment in advanced economies since the Second World War. Until recently, sovereign risk premium differentials in Europe have been small. This has changed. It now costs more to insure against a sovereign debt default by Spain and Italy than to insure against default by Latin American countries such as Brazil and Mexico. (See Chart: Bond yields.) States in southern Europe also have to pay higher interest rates than sound private borrowers in the euro area. There are also examples of states paying higher interest rates than the soundest of private borrowers in the same country. In spring 2010, Greece encountered acute payment problems.
There are examples of heavily indebted countries that have stopped the snowballing process before it led to default. The banking crisis in the early 1990s left Sweden with a substantial fiscal deficit. Lower tax revenues, increased social security expenditure and rescue measures for banks brought the deficit close to 11 per cent of GDP in 1993. Sweden’s public debt rose to 80 per cent of GDP. Fiscal consolidation continued for several years and resulted in stabilisation of government debt and provided room for its eventual reduction. The  13  See Michael Hoel and Jan F. Qvigstad (1986): “Statsgjelden – et problem når veksten er lav og renten er høy (Public debt – a problem when growth is low and interest rates high)”, Sosialøkonomen, and Unni Larsen and Bente Støholen (2010): “Public finances – the difficult path back to sustainable levels”, Economic Commentaries 2/2010, Norges Bank. BIS Review 123/2010  7  UK and Finland conducted a similar process in the 1990s. The Nordic countries in crisis at that time learned their lesson and have kept public finances in order during this crisis. The euro area countries are in a special position. They have a common currency and a common monetary policy. Governments raise loans in the area’s single currency. Monetary policy – management of the euro’s value – is a common policy, conducted by the European Central Bank with a view to maintaining price stability. The countries have common guidelines for fiscal policy, but as mentioned earlier, these have not been followed.