Category: Economical policy

Could public debt ultimately be an illusion? The question periodically resurfaces in economic debate: since eurozone central banks hold a substantial share of national public debt, why not simply cancel these securities? Or, failing that, refinance governments indefinitely at zero interest?

In both cases, the argument appears compelling: part of the debt would disappear from the government’s balance sheet, or would cease to generate interest costs. The budget constraint would therefore be eased without any need to raise taxes, cut spending or increase growth. Yet this conclusion is mistaken.

The first point is straightforward: since the Banque de France is wholly owned by the French state, this is essentially an accounting game in which the consolidated balance sheet of the state and the central bank is broadly unchanged overall (see box).

This accounting reality is sometimes obscured by the legal separation between the state and the central bank. Economically, however, they must be consolidated in order to assess the actual impact of the operation.

At the same time, in terms of income flows, because the Banque de France is owned by the state, its results also contribute to public finances, notably through corporate income tax and dividends. According to the Banque de France’s annual reports, the institution’s payments to the French state—including corporate income tax and the dividend paid to the state as shareholder—totalled approximately €36.8 billion over 2015–2025. This figure should be checked against the final published annual accounts for 2025 and the precise definition of “payments” used in the calculation.[1] Treating the state’s debt and the Banque de France’s assets separately therefore creates an optical illusion.

The PSPP provides an instructive case

Would the cost of such a cancellation, or of reducing the interest on this debt to zero, be shared across the eurozone through our central bank?

The Public Sector Purchase Programme (PSPP), launched in 2015, was not designed as a mechanism under which all risks associated with national public debt would automatically be mutualised.[2]

Public-sector securities were largely purchased on a decentralised basis: national central banks mainly purchased securities issued by their own jurisdictions, within an allocation framework guided by the ECB capital key. Under the PSPP’s original risk-sharing arrangements, purchases by national central banks accounted for the overwhelming majority of purchases and were generally held on their own balance sheets. Risk sharing applied only to specified portions of the programme, notably purchases by the ECB and certain supranational issuers; the ECB’s Governing Council stated that losses on national government securities purchased by national central banks would not be shared across the Eurosystem.[2][3]

This architecture is not a mere technical detail. It means that when a national central bank purchases the debt of its own government, the risk is not automatically transferred to taxpayers in other countries. If it were, the mere idea of the Banque de France cancelling French government debt would immediately provoke opposition from the other member states.

The Banque de France therefore bears, for the most part, the risk associated with the French public securities it acquired under the PSPP. Cancelling these securities would consequently not make other European states pay in France’s place. It would primarily reduce the assets of the Banque de France, while providing no improvement in terms of our fiscal room for manoeuvre. This statement should nevertheless be read subject to the Eurosystem’s accounting, capital and income-sharing rules, which determine how any losses would ultimately be absorbed.[2][3]

And what about zero-interest financing?

The same reasoning applies to the seemingly more subtle idea that the central bank could retain the securities but permanently waive the interest, refinancing the government at zero interest.

Again, the operation may look magical if one considers only expenditure in the government budget. But this too is an illusion.

Suppose the government pays €10 billion a year in interest to the Banque de France. For the government budget, this €10 billion is an expense. For the Banque de France, it is income.

The disappearance of the interest received by the central bank does not represent an equivalent net gain for public finances, because it entails a loss of income for the central bank and, consequently, a broadly equivalent reduction in the dividends and taxes it pays to the state budget. Once again, the operation is essentially a zero-sum game for the public finances as a whole.

More fundamentally, a central bank cannot permanently remove financial and fiscal constraints without creating significant risks.

Here, we need to return to a basic but fundamental distinction. A central bank can create money—central bank money, or M0—or facilitate the creation of bank money, reflected in broader monetary aggregates such as M2. But it cannot, through its monetary powers, create goods, services, labour, productive capital or productivity gains.

The creation of additional money can be extremely useful when it accompanies a growing economy or, as a countercyclical policy, helps support a recovery when productive capacity is underutilised. It is even at the heart of the functioning of the modern monetary economy. But it cannot permanently circumvent the budget constraint.

If the government wishes to devote structurally more resources to the green transition, defence, education, pensions or any other public policy, those resources must ultimately come from income generated by the economy: by reducing other expenditure, through taxation, by borrowing from savers and financial markets—and through sufficient growth in productive capacity to keep the debt ratio under control.

Money facilitates financing and organises exchange. It cannot, without serious risks, abolish fiscal and financial constraints. Excessive money creation relative to the creation of real wealth cannot permanently allow an economy to escape its underlying constraints. It creates the conditions for an economic, social and potentially democratic crisis.

The great danger of a loss of confidence

The argument against debt cancellation therefore goes beyond an accounting demonstration. Even if such an operation were legally possible—which already raises serious difficulties in the eurozone—it would be dangerous, potentially very dangerous.

First, it would fundamentally alter the perception of the central bank’s role. If markets came to believe that the central bank was permanently financing government deficits, the boundary between monetary and fiscal policy would become blurred, affecting expectations about both public finances and monetary policy.

The immediate danger would therefore be a higher risk premium. Public debt is not merely a figure on a balance sheet. It is also a promise made to future lenders.

A government’s ability to refinance itself at reasonable rates depends on confidence in its willingness to honour its commitments and on a debt trajectory regarded as sustainable.

If investors anticipated that governments could call upon the central bank to finance their deficits without limit, or regularly cancel public debt, they would question the future value of the currency and the sustainability of the monetary framework.

The paradox would then be striking. A policy designed to reduce the cost of debt could lead to a higher risk premium demanded by investors, and therefore to higher interest payments by the government. Since France must continually refinance a considerable portion of its outstanding debt, higher interest rates would progressively affect the overall cost of public financing. The constraint would not disappear; quite the opposite.

And what about the inflation risk?

The second risk concerns monetary stability. When the central bank permanently finances government deficits, which are therefore no longer constrained over the medium to long term, aggregate demand may grow faster than the economy’s productive capacity. This is consistent with the standard monetary and fiscal framework used by the IMF, the ECB and the Bank for International Settlements: inflationary pressure depends on the interaction between nominal demand, monetary and fiscal conditions, and the economy’s available productive capacity.[4][5]

As long as the economy has spare capacity, such monetary creation may not generate excessive inflation. But when productive capacity is already heavily utilised, inflationary pressures emerge. At that point, the central bank would normally need to tighten monetary policy. The empirical relationship is not mechanical or instantaneous, but the risk is well established in the literature and in central-bank analysis.[4][5]

Yet if the central bank becomes the government’s main automatic source of financing, raising policy rates becomes much more politically difficult. It would face a classic institutional conflict of interest, but one greatly intensified: fight inflation at the risk of increasing the cost of government financing, or maintain accommodative conditions in order to preserve fiscal solvency. Its ability to act in the common interest and defend the economy’s long-term interests would thereby be weakened.

Monetary credibility rests largely on the belief among economic agents that the central bank will do whatever is reasonably necessary to preserve price stability, even if such a policy may, at times, make public finances more difficult to manage. This principle is reflected in the ECB’s mandate and in the literature on fiscal dominance, which examines the risk that fiscal financing needs may constrain monetary policy.[5][6]

The serious long-term risk is a loss of confidence in the currency itself—in other words, in the system through which society settles transactions and debts. This is a deeper dimension, often absent from the accounting debate.

Money rests on trust. That trust makes it possible, with relative stability and reliability, to set prices, enter into commercial contracts, make loans and investments, and negotiate wage agreements. The entire organisation of the economy depends on this confidence.

A lasting loss of confidence in the currency is not limited to a few additional percentage points of inflation. It can lead economic agents to shorten their time horizons, slow investment and growth, favour real assets, reduce their holdings of money and increase conflict over the terms of contracts. The process can become self-reinforcing and lead to severe economic, social and broader societal disruption. These effects are not automatic, but episodes of high and unstable inflation show how inflation uncertainty can impair investment, financial intermediation and long-term contracting.[4][7]

Money is therefore not simply an accounting instrument that can be manipulated without consequences. As monetary theory—and, before it, economic history—has shown, monetary stability is one of the foundations of social order.

The reductio ad absurdum

If a government could permanently finance all its spending by issuing debt, then ask its central bank to purchase the securities it issued, waive the interest and/or cancel the corresponding claims without any economic consequences, why has this never been done? Poverty would have been eradicated!

Why, then, limit deficits? Why levy taxes at all? Why control public spending? Why worry about the level of debt? The answer is obvious: fiscal and financial constraints are not mere accounting conventions. They reflect constraints that are genuinely present in the real economy.

A government can borrow to invest, benefit from interest rates below its growth rate, or use monetary policy during a crisis. But it cannot permanently consume more resources than the economy generates without someone, somewhere, ultimately bearing the cost.

The real solution is economic, not monetary

The conclusion is not that public spending must necessarily be cut sharply or that austerity should be imposed. It is much simpler: the trajectory of the debt ratio must be addressed at its source.

For a country such as France, this means first restoring a credible fiscal path gradually, seeking a balanced—indeed, where economic conditions allow, a primary surplus—fiscal position. This requires better prioritisation of public expenditure, greater efficiency, higher employment and increased productivity—in other words, stronger potential growth.

Debt sustainability fundamentally depends on the relationship between the interest rate paid on debt, the nominal growth rate of the economy and the primary fiscal balance. In standard debt-dynamics notation, the change in the debt-to-GDP ratio can be approximated by:

When growth is insufficient and primary deficits persist, no monetary trick can solve the problem. Conversely, a more productive economy, employing a larger share of its working-age population and supported by more efficient public spending, makes debt mechanically more sustainable. The central bank can support this dynamic. It cannot substitute for it.

Olivier Klein
Professor of Economics and Finance, HEC Paris
Former Chief Executive Officer of a bank

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A cancelled debt, a depleted capital base

Let us begin with a seemingly straightforward operation. The French government owes €100 to the Banque de France. The Banque de France therefore records a €100 claim on the government as an asset, while the government records a €100 liability.

If the Banque de France cancels this claim, the government’s debt does indeed fall by €100. But, simultaneously, the Banque de France’s assets fall by €100, while its liabilities to banks, in particular, remain unchanged—in this case, banks’ reserves held in central bank money.

The result is therefore a corresponding reduction in the central bank’s net income and, potentially, in its equity, reflecting a loss of wealth. There is consequently no creation of wealth for the public sector considered as a whole, since the Banque de France is wholly owned by the French state.

Sources

[1] Banque de France, Annual Report, editions for 2015–2024, and Banque de France, 2025 annual accounts when published. See the sections on net income, corporate income tax, dividend paid to the French state and distribution of earnings: https://www.banque-france.fr/en/publications-and-statistics/publications/annual-report

[2] European Central Bank, “ECB announces expanded asset purchase programme,” 22 January 2015, describing the PSPP’s decentralised implementation and risk-sharing framework: https://www.ecb.europa.eu/press/pr/date/2015/html/pr150122_1.en.html

[3] European Central Bank, The ECB’s monetary policy, section on the asset purchase programme and risk sharing; see also the ECB’s PSPP legal acts and implementation decisions: https://www.ecb.europa.eu/mopo/implement/app/html/index.en.html

[4] European Central Bank, “Monetary policy strategy,” including the ECB’s analysis of inflation, demand pressures and price stability: https://www.ecb.europa.eu/mopo/strategy/html/index.en.html

[5] International Monetary Fund, Fiscal Monitor and related work on fiscal policy, inflation and fiscal dominance: https://www.imf.org/en/Publications/FM

[6] European Central Bank, “The monetary-fiscal policy mix in the euro area,” and related ECB research on fiscal dominance and central-bank independence: https://www.ecb.europa.eu/pub/economic-research/html/index.en.html

[7] Bank for International Settlements, research on inflation, inflation expectations, monetary stability and macroeconomic performance: https://www.bis.org/list/research/index.htm

[8] European Commission, Debt Sustainability Monitor, which sets out debt-dynamics identities and the role of interest-growth differentials and primary balances: https://economy-finance.ec.europa.eu/economic-and-fiscal-governance/debt-sustainability-monitor_en

[9] International Monetary Fund, Debt Sustainability Analysis for Market-Access Countries, technical guidance on debt dynamics and debt sustainability: https://www.imf.org/external/np/pp/eng/2013/050913.pdf

The European Commission’s new demographic report confirms a long-term trend: Europe is entering a period of sustained ageing and population decline. The European Union’s population is expected to peak at around 453 million in 2029 before falling to approximately 399 million by 2100. Driven by declining fertility and rising life expectancy, this shift will profoundly alter the age structure of our societies. The economic consequences are considerable: tensions in the labour market, rising healthcare expenditure, growing pressure on pension systems and increasing strain on public finances.

Three levers can help mitigate these effects: immigration combined with a high employment rate, stronger productivity gains, and an increase in the number of people actually in work. The first cannot be sufficient on its own. The second is essential, but cannot simply be decreed. It depends on innovation, investment, education and the ability to spread the benefits of new technologies rapidly and widely.

One lever, however, can be mobilised immediately: employment. The European Commission points out that bringing the employment rates of EU Member States closer to the highest levels observed in Europe would substantially reduce the economic impact of ageing. The employment rate among 15- to 64-year-olds exceeds 80% in Sweden and the Netherlands, compared with 77.4% in Germany, 76.9% in Denmark, 71.8% on average across the European Union, and just 68.8% in France.

The total number of hours actually worked per capita provides additional insight. It combines demographic trends, the employment rate, the prevalence of part-time work and annual working hours. France is around 14% below the European average. It therefore combines an employment rate that is too low with annual working hours for full-time employees that are approximately 7% below the European average.

This reality is decisive for the future of our social model. A generous welfare state requires a sufficiently broad productive and contributory base. The more hours people work per capita, the more sustainably it is possible to finance high-quality public services and an ambitious social protection system without endlessly increasing taxes or public debt. Potential growth, living standards and the sustainability of public finances depend directly on this. Ultimately, a higher employment rate also contributes to greater social cohesion.

France is particularly affected. Since the beginning of the 2000s, its GDP per capita has fallen behind the European average, and even more so compared with Germany and the Nordic countries, while its fiscal position has steadily deteriorated. Raising the employment rate would therefore have a major macroeconomic impact. By moving closer to Germany’s level, France would significantly improve its public finances; at the level of the Netherlands, simulations show that it could almost eliminate its primary deficit. It would also help restore the financial balance of our pension system.

Pension reform should therefore not be viewed solely as a means of preserving the pay-as-you-go pension system. It is part of a broader economic strategy aimed at increasing the number of people in work, raising potential growth, improving living standards and durably restoring our public finances. For France, the stakes therefore go well beyond pensions: they concern our future prosperity, the sustainability of our social protection system and, ultimately, our financial sovereignty.

Olivier Klein
Professor of Economics at HEC
Author of Debt, Reform and Democracy: Breaking France’s Vicious Circle

May 2026

Private credit has become a major source of corporate financing, but its rapid expansion shifts risks outside bank balance sheets without eliminating them. Opacity, leverage, illiquidity and growing interconnections are creating new vulnerabilities within the financial system that warrant closer oversight.

The rise of private credit has been one of the most significant financial developments of recent years. Long regarded as a niche segment, it has become an important source of funding for companies, particularly mid-sized firms and transactions considered too risky or too specialized for traditional bank lending. This growth reflects a genuine economic rationale: companies seek more flexible, accessible, or complementary sources of financing, while investors search for higher yields. Yet it also raises an increasingly pressing financial stability question. As credit migrates away from bank balance sheets, risks do not disappear; they merely change form, ownership, and transmission channels.

To fully understand the issue, it is useful to distinguish between a bank and a non-bank financial intermediary. A bank creates deposit money, collects deposits, transforms liquid liabilities into longer-term loans, has access to central bank liquidity facilities, and operates under a stringent prudential framework. When a bank grants a loan and retains it rather than securitizing it, the associated credit risk remains on its own balance sheet. If the borrower’s creditworthiness deteriorates or defaults, the resulting cost is reflected in provisions and ultimately in earnings. Unless the bank itself is threatened, depositors do not directly bear the cost of credit losses. Banks also assume interest-rate and liquidity risks. Banking regulation largely stems from this reality: because banks create broad money, operate payment systems, and safeguard a significant share of household and corporate savings through deposits, they are subject to strict prudential requirements. For the same reason, central banks can act as lenders of last resort to prevent a financial or banking crisis from spiralling into a systemic collapse.

Risk Transferred to Investors

Private credit funds operate according to a fundamentally different model. They do not collect deposits, perform a monetary function, or generally have access to central bank refinancing. Most importantly, they do not themselves bear credit, interest-rate, or liquidity risks. Those risks are transferred directly to the investors who commit capital to the fund and who, in exchange for higher expected returns, agree to absorb potential losses. This structure has an internal logic: it enables the financing of riskier segments without directly exposing depositors to those risks. However, it also has a downside. When risk is not internalized by the intermediary itself, balance-sheet discipline becomes more diffuse, oversight more fragmented, and market reactions during periods of stress potentially more abrupt.

Since the global financial crisis, banks have been subject to significantly stricter prudential requirements. This has strengthened their resilience, as was necessary, but it has also contributed to shifting part of corporate financing—particularly the riskiest and least standardized segment—outside the banking sector. At the same time, years of exceptionally low interest rates encouraged insurers, pension funds, family offices, and other institutional investors to seek higher returns in less liquid and riskier assets. Private credit has flourished at the intersection of these two trends: tighter constraints on banks and a growing appetite for yield among investors.

Multiple Vulnerabilities

This new form of credit intermediation nevertheless concentrates several vulnerabilities. The first concerns the quality of borrowers themselves. Companies financed through private credit are often unrated or only lightly covered by public rating agencies, and may exhibit fragile capital structures and elevated leverage. Aggressive deal structures, covenant-light loans, payment-in-kind (PIK) features, and discreet restructurings can delay the visible recognition of losses without reducing the underlying risk. In other words, credit deterioration may take longer to appear in valuations than in the underlying economic reality.

A second vulnerability lies in the sector’s limited transparency. Unlike publicly traded bonds, private loans do not trade on organized and liquid markets. Their valuation relies on models based on imperfect comparables and internal assumptions. This opacity is not merely an information issue for investors. It is also a macroprudential concern, as it delays the recognition of losses, complicates risk comparisons across market participants, and may foster a misleading perception of stability. The growing use of private ratings adds a further layer of ambiguity. While such ratings may broaden the investor base, they may also facilitate forms of regulatory arbitrage if their quality and consistency are not adequately ensured.

A third vulnerability stems from interconnections. Private credit does not operate in isolation from the broader financial system. Banks provide credit lines to funds, finance portfolios, share borrowers, and increasingly form partnerships with major asset managers. Insurers and pension funds invest in private credit to capture illiquidity premia that appear compatible with their long-term liabilities. Private equity groups may simultaneously control lending platforms and insurance companies, multiplying potential channels of contagion. The systemic risk therefore does not arise from an isolated “shadow sector,” but from an increasingly dense web of relationships among banks, non-bank financial institutions, insurers, and investment vehicles.

Liquidity Under Scrutiny

A growing liquidity risk must also be considered. As long as private credit is primarily financed through closed-end funds, the mismatch between investor liabilities and the illiquid nature of the underlying assets remains relatively limited. However, the rise of evergreen vehicles, semi-liquid structures, and products aimed at a broader investor base is altering this balance.

Whenever a degree of liquidity is promised to investors while the underlying loans remain difficult—or potentially impossible—to sell quickly, a mismatch emerges. In periods of stress, such mismatches can trigger forced sales, sharp markdowns, and spillovers into other market segments. This is precisely the type of vulnerability often highlighted in discussions of non-bank financial intermediaries (NBFIs): institutions that do not create money but can nevertheless become powerful amplifiers of instability through liquidity demands and asset sales.

A Useful Market That Requires Better Oversight

The debate should not be caricatured. Private credit is not inherently problematic. It addresses genuine financing needs and can usefully complement bank lending. The problem arises when the growth of this form of intermediation creates the illusion that risk has diminished simply because it has migrated away from bank balance sheets.

Transferred risk is not eliminated risk. When borne by end investors, valued infrequently, financed through leverage, and embedded within complex structures, risk may actually become more difficult to identify and more costly to contain once it materializes.

For this reason, the appropriate response is neither laissez-faire nor the mechanical extension of banking regulation to institutions that perform different functions and possess fundamentally different liability structures.

The first requirement is greater transparency. Authorities should harmonize definitions of private credit, impose more consistent reporting standards, and obtain sufficiently granular information on funds, loans, credit quality, leverage, liquidity terms, and interconnections with banks and insurance companies. As long as this mapping remains incomplete, supervision will remain behind the curve.

The second requirement is a more cross-sectoral approach to supervision. The risks associated with private credit cannot be properly assessed within separate silos of banking, securities-market, and insurance supervision. Regulators need to monitor consolidated exposures, cross-financing channels, leverage, and liquidity risks across the financial system as a whole. Such an approach is essential to identify areas where an apparently localized shock could become systemic.

The third requirement is proportionate regulation of amplification mechanisms. This implies stricter oversight of valuation practices, greater scrutiny of private ratings, limits on excessive leverage at the fund level, and more robust requirements regarding margins, haircuts, and consistency between promised liquidity and the actual liquidity of underlying assets. The objective is not to restrict non-bank financing but to prevent it from becoming a major source of instability through the absence of adequate safeguards.

Many of these measures are already advocated by national and international institutions responsible for safeguarding financial stability.

A Turning Point for Private Credit

Private credit is now at a pivotal stage of its development. Its growth demonstrates the financial system’s capacity to innovate and to meet financing needs that banks no longer fully satisfy on their own. Yet it also reminds us of a familiar lesson: the further risk moves away from the perimeter where it has historically been most closely monitored, the greater the temptation to assume that it has become less significant.

The opposite is often true.

When banks retain the loans they originate, they absorb the associated costs on their own balance sheets. When private credit funds finance similar risks, it is investors who ultimately bear the losses. Such a transfer may be economically justified, but it does not warrant prudential complacency or regulatory leniency.

As private credit becomes increasingly systemic, supervision must evolve and strengthen alongside it.

Private Debt and Risk:

Three Key Takeaways

• Private credit meets a genuine corporate financing need, but it does not eliminate risk; it transfers it from bank balance sheets to investors.
• Its rapid expansion increases several sources of systemic vulnerability, including opaque valuations, elevated leverage, illiquid assets, and strong interconnections with banks, insurers, and investment funds.
• The key challenge is therefore to establish a supervisory framework that is more transparent, cross-sectoral, and proportionate, capable of containing amplification mechanisms without unnecessarily constraining this important source of financing.

Olivier Klein

Professor of economics at HEC