France’s Government Debt Adds to Europe’s Inflation Risk

France, like Greece in 2010, has arrived at an unsustainable fiscal impasse, and it is possible that within a few years the market will conclude that France’s debt-to-GDP ratio implies it will have to default or get bailed out by the European Central Bank through monetization of its public debt.  

Its government debt-to-GDP currently stands at 118%, its current fiscal deficit is nearly 6% of GDP, and its government debt-to-GDP is projected to rise to 125% by 2030. Like Greece, and unlike the U.S., France cannot unilaterally monetize its unsustainable deficits, and France like Greece in 2010, is now the weakest fiscal link in the eurozone. French 10-year bonds have a yield to maturity of 3.47%, which is substantially above those of Germany (2.84%) and the Netherlands (2.91%).  

Many observers justifiably fret about the exploding government debt-to-GDP ratio in the U.S. and the consequent risk of “fiscal dominance” – the possibility that without a major reform of Medicare and Social Security (which currently report a combined negative present value of about $100 trillion), the Federal Reserve soon may have to step in to buy government bonds, producing a higher inflation rate.  

Greek Lessons 

As the Greek crisis of 2010-2020 illustrated, inflation is not the only possible unpleasant outcome of an unsustainable accumulation of government debt. Members of the eurozone all issue their individual government debts in a currency that they jointly control. In the Greek case in 2011, that meant that an unsustainable debt buildup produced a Greek debt restructuring. Note how quickly the Greek crisis and debt write-down of 2010-2012 occurred once its debt accelerated above 100% in 2010 (rising to a debt-to-GDP of about 130%). Its privately held government debts lost about three-quarters of their value as part of the necessary adjustment, and its other debts were heavily subsidized by its eurozone partners to help Greece regain sustainability. 

In the wake of its debt crisis, Greece resisted fiscal reform for many years, which resulted in a persistent loss of real income per capita and a 10% decline in its population. But since 2020, fiscal and other reforms have borne fruit. The government debt-to-GDP ratio, while very high at about 150%, is on a downward trajectory, and Greece is growing at an above average rate among European Union countries. And a new Greek political party is forming and gaining ground by promising to finish the work of reform, especially by rooting out corruption. 

Monetization 

 Monetization rather than default seems the more likely outcome for France. Unlike Greece, France is one of the largest countries in the eurozone, and a default on French debt would have more far-reaching consequences than Greece’s smaller debt write-down fifteen years ago. Symbolically, a French default seems unthinkable; France (along with Germany) was one of the two countries at the center of the euro’s creation, and two of the ECB’s four presidents have been French, including the current President, Christine Lagarde.  

A new ECB policy instrument that would allow the ECB to monetize French debt is conveniently on hand. A new funding mechanism was established at the ECB in 2022 called the Transmission Protection Instrument (TPI). The TPI can be used to counter “unwarranted, disorderly market dynamics,” and would permit the ECB to purchase government debt of any member country in response to declining market prices. Although French fundamentals, if they persist, clearly would justify a major further price decline in French debt, the ECB would be free to view such a decline as “unwarranted,” and doing so would be the obvious path of least resistance.  

If the TPI were used to bail out the French, under its rules the ECB is supposed to prevent any consequent acceleration of inflation by reducing its purchases of other debts. But how will Germany, the Netherlands, Spain, Italy, and other eurozone members react to that back-door bailout of profligate France at their expense? For that reason, France’s fiscal crisis could lead to a euro-zone decision to tolerate a rise in inflation, even though this would violate the ECB’s low-inflation mandate. 

There is an additional fiscal risk. The largest French banks are among the most vulnerable in the eurozone. According to the SRISK model produced by finance professors at New York University’s Stern School, France’s banks are much more vulnerable to a major global shock than the banking systems of other European countries.  The cost of recapitalizing them in the wake of a major global shock could add substantially to the French government’s debt-to-GDP ratio — roughly nine percentage points, according to the Stern School estimate of an SRISK for French banks of $280 billion. 

Toothless Maastricht Criteria 

When the eurozone was founded, its members created a common fiscal standard known as the Maastricht Criteria, which limited each country’s annual fiscal deficits to 3% of GDP and its outstanding government debt to 60% of GDP. 

But this standard has proven to be toothless. France has been in violation of the Maastricht Criteria for years. It routinely meets with the managers of the European Deficit Procedure (EDP) to promise fiscal reforms consistent with its returning to the deficit levels consistent with the Maastricht Criteria, but so far the French electorate has made sure that those promises never materialize.  

By contrast, despite its high government debt-to-GDP ratio of 138%, Italy’s deficits in the past two years (3.4% in 2024 and 3.1% in 2025) have been on a declining path. Although Italy remains a concern (its ten-year government debt is yielding 3.56% currently), its ability to reduce deficits (which were 7.2% of GDP in 2023 and 8.1% in 2022) has been a welcome sign. It is likely that French government debt would be yielding even more than its current 3.47% if the market were not already pricing in the likelihood of a bailout from the ECB. 

France, like the U.S., seems unwilling to reduce spending even as its debt-to-GDP ratio grows to the point of unsustainability. In particular, France rejects common-sense increases in the minimum retirement age for pension eligibility. According to OECD data, the percentage of people in France who work after age 65 is only four percent, in contrast to seven percent in Germany, nine percent in the United Kingdom, and 20 percent in the U.S. 

There is no sign yet of a French political change of heart to avoid the looming fiscal cliff, and there is no obvious mechanism through which the EDP can produce fiscal reform in France. And if Europe doesn’t find a way to discipline fiscal free riders, it is sure to have many more cases to solve in the future. 

To further complicate matters, as Europeans search for a way to implement credible fiscal discipline, they have a common interest in encouraging member countries to expand their defense spending to counter potential Russian belligerence. How the eurozone will adjust to the impending French debt crisis, while building its own defense capabilities, will be major tests of European and ECB leadership over the next two or three years.