The Confidence Fairy Comes for France

Those who dismissed fiscal restraint in the 2010s overlooked something important. France is now paying the price.

The economists who dismissed fiscal restraint in the 2010s overlooked something important. France is now paying the price.

Well, well, well.

Paul Krugman has discovered that France has a debt problem. In a Substack post published this week, the Nobel Prize-winning economist warns that France is on an unsustainable fiscal path. Worse, because France is a member of the eurozone, its fiscal troubles could threaten the broader European economy.

But for those of us who warned about these very dangers after the financial crisis, his newfound concern is quite something to behold. I was among the economists arguing that European governments needed to get their fiscal houses in order, preferably by restraining spending rather than by raising taxes. Fiscal adjustments reduce the debt-to-GDP ratio more effectively through spending reforms than through tax increases, and France is already heavily taxed.

Paul Krugman and others, by contrast, argued that fiscal consolidation was misguided, even dangerous, especially while economies remained weak. Krugman was especially dismissive. In a July 2010 New York Times column, he mocked those of us who were nervous about excessive borrowing, suggesting our arguments rested on imaginary bond-market vigilantes and a mythical confidence fairy.

In November 2013, he published a column titled “The Plot Against France.” The occasion was Standard & Poor’s decision to downgrade French government debt. Krugman was outraged, arguing that French borrowing costs were low and that markets seemed unconcerned. He argued that the downgrade reflected an ideological campaign against a country unwilling to embrace the austerity agenda.

In January 2014, he attacked François Hollande’s turn toward spending restraint and supply-side reform. Later that year, in “The Fall of France,” Krugman again criticized Hollande for yielding to austerity pressures. According to the Nobel laureate, France didn't need the fiscal medicine its critics prescribed. The real danger was austerity itself.

Fast-forward to October 2026. France’s public debt is approaching 120 percent of GDP. Its deficit remains around 5 percent of GDP despite the absence of a major economic emergency. Its spending is around 57 percent of GDP, and it is the second-highest-taxed nation in the OECD. Borrowing costs have risen, investors are nervous and scaling back, and politicians are struggling to agree on even modest reforms. See the great piece by Mercatus’ Emergent Scholar Geert Ensing.

So now Krugman worries about France. What changed?

Certainly, interest rates changed. But that’s precisely the problem with the economic advice he and others offered the French government earlier. One central argument against fiscal consolidation after the Great Recession in the 2010s was that interest rates were low. Why worry about debt, the argument went, when governments can borrow so cheaply? We heard this in the U.S. too. Keynesian economists also argued that, at the zero lower bound, government spending would generate unusually large economic multipliers. Additional spending would increase output, employment, and tax revenues. Conversely, cutting spending would depress growth and could even worsen the debt-to-GDP ratio.

But as I mentioned before, the issue back in the 2010s was never that government couldn’t borrow at low rates. It was that it was unwise, given that we knew entitlement spending was on the verge of exploding without fiscal backing, requiring more debt. That meant that even if rates stayed low, low rates on enormous debt are expensive, and enormous debt is dangerous when rates start rising.

Indeed, the debt doesn’t disappear when interest rates change. As Stanford economist Hanno Lustig recently observed on X, “Government debt/GDP is a persistent state variable. Bond yields are not. If the only reason you’re changing your mind is that yields are up, then your advice wasn’t that good to begin with.” That distinction should have been central to the debate all along. France accumulated debt over decades. The stock remained even as the favorable financing conditions that made it seem manageable disappeared. It was never prudent to conduct fiscal policy on the assumption that exceptionally low interest rates were permanent. The same is true in the US.

The second mistake was treating government spending as though it could generate enough economic growth to substantially offset its own cost. This was always a much more uncertain proposition than the public debate suggested. In a 2021 paper with my colleague Garett Jones, “Keynesian Stimulus: A Virtuous Semicircle?,” we reviewed the empirical literature on government-spending multipliers. The evidence offered little support for the notion that additional government spending reliably produces such large increases in economic output that the spending effectively pays for itself. Multipliers vary considerably depending on economic conditions, the type of spending, monetary policy, and how the spending is ultimately financed.

In subsequent work with Jack Salmon, we examined another important finding. Fiscal multipliers tend to become smaller as government debt increases. If heavily indebted governments receive less economic stimulus from each additional dollar of spending, borrowing more becomes an increasingly expensive way to generate growth. In part, this is because large governments tend to spend mostly on transfer payments. France illustrates the problem. Successive governments responded to economic difficulties with additional spending and borrowing. Yet the country never generated sustained growth or fiscal surpluses necessary to reverse its debt accumulation.

The third mistake was forgetting something that American policymakers once understood remarkably well: The Hamilton norm. The idea goes back to Alexander Hamilton’s 1790 “Report on Public Credit” and the fiscal principles that helped establish the credibility of the young American republic. Governments must sometimes borrow heavily for wars, financial crises, pandemics, and other emergencies, which can justify extraordinary deficits.

But borrowing during an emergency comes with the obligation that, when the emergency ends, fiscal policy must adjust so the debt remains credibly backed by future government resources. In other words, deficits beget surpluses, as UVA’s Eric Leeper writes. The point isn’t that every dollar borrowed must be repaid immediately, or that governments must balance their budgets every year, but that borrowing must be accompanied by a credible expectation of future fiscal adjustment.

That expectation lets governments borrow during emergencies without undermining confidence in their debt. Government debt is ultimately a claim on future fiscal resources. Investors must believe that the government will generate sufficient future primary surpluses, appropriately discounted, to support the value of its outstanding obligations. If that expectation disappears, the consequences need not take the form of an immediate default.

These ill consequences can emerge through higher risk of premiums, financial instability, or inflation. The crucial insight is that fiscal credibility is accumulated over time. It cannot simply be summoned when investors become nervous. This is why waiting until bond markets force governments to act is such a dangerous strategy.

I am glad that Krugman has woken up to the fact that France faces a fiscal problem, but I would be gladder if economists were more consistent in acknowledging that the fiscal problem has always been there, and that it didn’t just emerge today through higher interest rate pressures.