For much of the last decade, financial markets were willing to grant governments the benefit of the doubt. Spiraling deficits, rising entitlement costs and geopolitical shocks were absorbed with relative calm, as interest rates hovered near zero and central banks stood ready with the safety net of large-scale asset purchases. It was a period in which public debt was largely treated as benign — if not invisible.

That era is over.

On the surface, this might seem like a mechanical reaction to changing monetary policy. But beneath, something deeper is stirring. The bond market is beginning to doubt the underlying political capacity to manage debt, and finding it wanting.

As the post-pandemic world settles into a more fractured and inflation-prone equilibrium, governments are being forced to confront the realities of high spending, rising interest burdens and slowing structural growth.

In broad terms, there are three possible responses to this dilemma, each with distinct risks and consequences.

The first path is to rely, either deliberately or by inertia, on inflation as a mechanism of debt relief. By allowing inflation to run higher than interest rates, governments can reduce the real burden of their liabilities without having to raise taxes or cut spending, at least in the short term.

This strategy, which economists refer to as “financial repression,” helped lower debt ratios in the decades after World War II.

Once markets begin to suspect that inflation is being tolerated rather than contained, the result is not relief, but repricing. Yields rise. Currencies weaken. Capital takes flight. And the short-term fix gives way to long-term instability.

Inflation, once out of the bottle, rarely plays nice. At best, if offers a temporary sleight of hand — at worst, a destructive spiral.

The second path is the route of forced consolidation under duress, a scenario that typically unfolds when policymakers hesitate too long and investor confidence collapses and markets crack the whip. We have seen this movie before.

The United Kingdom’s 2022 gilt meltdown under Liz Truss offered a modern masterclass: Markets can humble even developed economies within days. History, from Greece to Argentina, is littered with examples of fiscal drift addressed too late. In such episodes, bond yields can spike dramatically and rapidly, triggering emergency austerity measures, political upheaval and severe social stress.

The third and most constructive path is one of proactive reform — a deliberate effort to restore credibility through pension and healthcare reforms, targeted expenditure control and structural improvements to the tax base.

Different economies are navigating these choices with varying degrees of clarity — or confusion.

In the U.S., the so-called “big, beautiful bill,” with its sweeping tax cuts and spending pledges, has added to the impression of fiscal drift.

Across the Atlantic, attention is shifting from the usual suspects. For years, Italy was viewed as Europe’s most precarious sovereign. But with relative political stability and a more transparent fiscal trajectory under Prime Minister Giorgia Meloni, Rome has begun to reassure markets, at least for now.

France, in contrast, is raising eyebrows. Recent bond spreads suggest that investors are beginning to question Paris’s capacity to govern, let alone to reform.

Japan, long considered a unique case due to the domestic ownership of its debt and the Bank of Japan’s formidable bond-buying power, is no longer immune to pressure. As inflation has begun to rise and the political landscape becomes more fragmented, long-term yields have started to climb. With more political instability looming, Japan’s markets seem to be bracing for turbulence.

Complicating this picture are several external forces that make the task of fiscal repair even more challenging.

And although technological change offers the promise of higher productivity and better revenue collection, it also brings disruption, inequality and transition costs that governments cannot ignore.

Taken together, these trends mean that fiscal prudence is harder, but also more necessary, than it has been in decades.

Each new budget, monetary policy decision or geopolitical flare-up has the potential to shift sentiment and shed more light on who will ultimately prevail: the reformer, money printing press or market scourge.

In the words of Augustin Carstens, general manager of the Bank for International Settlements: “Central banks cannot be the only game in town.”