Government debt, economic fundamentals and OTC derivatives in the G7

Abstract

The financial crisis has contributed to increase the debt-to-GDP ratio in G7 countries that intervened to ensure a softer landing for their economies; the stockpiling of public debt among G7 countries in the presence of slow growth makes policy coordination necessary to reduce the potential risks of regulatory arbitrage and moral hazard. Since 2016, G7 countries reversed the path of enhanced regulatory coordination in the global financial system. The changing global regulatory environment and the opaqueness of debt management practices with OTC contracts increase the financial risks and undermine public debt sustainability, regardless of the structural reforms undertaken so far. Among the G7, France, Italy and Germany share common public debt and fiscal policy rules and the euro, but these rules will be unable to effectively stabilize debt and reach the 60% target by 2031. The empirical evidence presented in this chapter confirmed that financial markets are able to price the countries’ stabilization ability of public debt. This ability has significant political consequences for G7 countries.