Preventing "bad" debt from chasing "good" debt

Not all debt is created equal. In theory, in the case of public administrations, borrowing is justified to cover expenditure to prepare for the future, or to spread over time the budgetary impact of exceptional, non-recurring shocks, such as war or a deep economic recession. On the other hand, it is unjustified if it unjustifiably transfers to future generations the financing of expenditure that benefits present generations alone.

The golden rule for public finances: a rule with no operational basis

This principle, often referred to as the “golden fiscal rule”, would draw a line between “good” public debt financing investments and “bad” public debt financing operating expenses or social benefits. However, its application would not only raise major practical difficulties, but would not guarantee the sustainability of the public debt trajectory.

First of all, delimiting the “right” expenses to be financed by debt would be anything but straightforward, and would be open to interpretation. For example, to what extent is the remuneration of teachers or researchers an expense that prepares for the future? Secondly, bonds issued by governments are not earmarked to finance a specific project or item of expenditure – which would require specific revenues to be earmarked – but are intended to cover all financing needs, without distinction between good and bad deficits. There is only one undifferentiated quality of debt for any one issuer. Last but not least, public spending on investment or preparing for the future is often more socially than financially profitable, i.e. it does not generate enough additional future income to cover borrowing costs. And yet, all public debt, whether good or bad, must be backed by future revenues and find investors willing to hold it.

Sustainability that does not depend on the nature of the expenditure

In fact, there is no guarantee that a “good” public deficit is sustainable. For example, even if we strictly restrict the scope of public investment to that used in national accounting, a rule limiting the deficit to the amount of public investment would authorize a deficit ratio of around 4.5% of GDP in the case of France, admittedly lower than the 5.1% recorded in 2025, but much higher than the 3% that would be needed at the very least to stabilize the debt/GDP ratio at around its current level of 116%.

The quantity trap: when good debt turns against itself

In other words, “good” debt is not just a question of quality, but first and foremost of quantity. Hence another form of “Gresham’s Law” for debt: not only does bad debt crowd out good debt, but good debt becomes bad as it grows.

However, this does not mean that the quality of the expenditure to be financed is irrelevant. It’s precisely because the quantity of sustainable debt is limited that we need to make trade-offs, giving priority to spending that best prepares us for the future. This will also reduce the credit risk in the eyes of lenders: future generations will be more willing to assume the debts bequeathed by previous generations if they perceive direct or indirect benefits for their well-being.

The exception clause: an illusory solution

Contrary to a temptation that recurs from time to time, the solution is not to authorize governments to derogate from deficit and debt norms by removing certain expenditures (investments, climate transition, defense, etc.) from their calculations. This good debt would then not replace the bad debt, but would be added to it, and thus contaminated by it. If the political authorities deem it absolutely essential to increase such spending within the framework of a sanctuarized multi-year programming law (such as the military programming law), then other spending (or taxes) will have to be adjusted accordingly to meet the required public debt trajectory. Provided, of course, that such programming laws are not multiplied…