Beware the Costs of the Global Rearmament Boom

Rebecca Patterson is a globally recognized investor and macroeconomic researcher. She is the co-host of the CFR podcast The Spillover, which addressed this topic in its most recent episode.

Government leaders today want guns and butter. Financial markets are starting to signal that they can’t afford both.

For the last eleven consecutive years, global military spending has been increasing, according to data from the Stockholm International Peace Research Institute (SIPRI). In 2025, global spending surpassed 2.5 percent of gross domestic product (GDP), its highest level since 2009.

At the same time, many leaders have shown no interest in materially cutting spending on voter-friendly domestic programs to make fiscal room for more weapons. At a time when global government debt is nearing 100 percent of GDP, according to the International Monetary Fund (IMF), politicians want both guns and butter.

Especially in recent years, the renewed focus on defense has been driven by fears over hot wars in Europe and the Middle East, heightened geopolitical tensions around the world, and questions about the resilience of historic alliances. Indeed, this backdrop pushed Europe’s leaders to increase military spending by 14 percent last year compared to 2024, while in Asia, spending rose by 8.1 percent over the same period.

The risk of this spending is that continued rearmament, without a material increase in the pace of underlying economic growth or budget changes to increase revenues or cut spending elsewhere, may structurally lift borrowing costs or even fuel a crisis. Politicians overseeing budgets need to understand the policy risks that global bond investors are already noting.

Rearmament is unlikely to slow anytime soon

With the number of global conflicts at the highest level since the end of World War II, according to CFR’s Conflicts to Watch in 2026, global military spending appears likely to continue increasing. At the 2025 NATO summit, all thirty-two member states (except Spain, which received an exemption) agreed to raise annual defense-related spending to 5 percent of GDP by 2035, in part due to pressure from the U.S. government. Meanwhile, Japanese Prime Minister Takaichi Sanae has pledged to continue Japan’s historically significant shift toward more defense spending. Japan reached its 2 percent-of-GDP defense goal in 2025, two years ahead of schedule. Revisions to the government’s three core national security strategy documents are due by the end of this year—those documents will shape future defense spending plans. A path toward even greater, more NATO-like spending seems plausible.

Perhaps most strikingly, the White House has proposed a $1.5 trillion defense budget [PDF] for fiscal year 2027—this would mark a 40 percent increase over previous budgets and the largest Pentagon budget in U.S. history, even after adjusting for inflation. Even if the budget is ultimately trimmed, the direction of travel is toward greater defense outlays.

At the same time, the Donald Trump administration continues to push U.S. allies to spend more on their own defense, reducing reliance on the United States. Speaking at the Shangri-La Dialogue in Singapore on May 30, Secretary of Defense Pete Hegseth said the U.S. “approach asks Pacific nations to do what many are already eager to do: invest seriously in their own defense, contribute more to collective security.”

More military spending leads to bigger budget deficits

Especially where recent military conflicts have been physically close, voters have been broadly supportive of greater defense spending. That support often fades, however, when the same respondents are asked what they would give up to pay for more guns.

For instance, a June 2025 YouGov poll indicated that 49 percent of respondents in the United Kingdom favored increased defense spending, but 57 percent opposed raising taxes to pay for it and 53 percent opposed cutting other government spending to fund it. In a similar vein, a March 2025 Ipsos poll suggested that two-thirds of French households favored a larger defense budget but half of respondents opposed cutting any public services to pay for it. Instead, 66 percent favored financing the defense budget through larger deficits.

Part of this household bias stems from the post-pandemic price spikes that have increased anxiety about the cost of living. Many voters seem to expect governments to help fill that affordability gap—indeed, recent elections, particularly in France, have punished politicians that suggested any degree of fiscal austerity.

Perhaps not surprisingly then, the IMF found in an April 2026 study [PDF] that roughly two-thirds of recent national boosts in defense spending were deficit financed, and that the average recent defense spending “boom” was followed by an increase in the country’s fiscal deficit of about 2.6 percentage points three years after the boom’s start. Public debt-to-GDP ratios rose about 7 percentage points over the same period.

A country’s fiscal health isn’t just a function of government deficits, of course. The pace of economic growth and the cost of borrowing also drive fiscal sustainability math. In that light, defense hawks point to the potential boost to economic growth from greater government spending. Such an argument is reasonable at first glance. Consider just the United States: the White House’s $1.5 trillion defense budget proposal is 50 percent greater than what is expected to be spent this year on artificial intelligence infrastructure, the latter frequently being cited as a major support for the broader economy.

Still, the IMF’s April study highlights that whatever growth emerges from defense spending depends on a number of variables—including how much of that spending goes to domestic versus imported goods, how much goes to personnel and research and development, and how tight the labor market is at the time of spending. Overall, the IMF suggests caution around defense-related growth forecasts. It’s far from clear that rearmament can be a significant force to help a country grow its way to a sustainable fiscal path, just as it is uncertain how much and when AI will lift different countries’ economies through greater productivity.

War-driven inflation exacerbates fiscal and market challenges posed by rearmament

Further complicating the ongoing defense spending increases is an already problematic inflation backdrop. While down sharply from its 2022 highs, inflation across many advanced economies started 2026 stubbornly above central bank targets, limiting policymakers’ ability to ease monetary policy.  

The war in Iran and subsequent global supply chain pressures have worsened that inflation picture in recent months, with the IMF suggesting different degrees of additional inflation pressure in 2026 and potentially into 2027 depending on the duration and severity of the conflict. Indeed, those price pressures have pushed a few central banks, such as the Reserve Bank of Australia, to increase policy interest rates in recent months, while several others are now increasingly discussing the possibility of rate hikes later this year. That’s a sharp contrast to the rate cuts that were expected this year by investors before the start of the war.

Higher policy interest rates are emerging alongside expected additional government bond issuance to fund more guns and butter. Investors are questioning whether sufficient demand will emerge to absorb that increased bond supply, especially on the part of foreign central banks that may not have the same degree of confidence in the U.S. Treasury market as they have historically—for fiscal, political, or geopolitical reasons. As a reminder, foreign central banks own about 30 percent of outstanding U.S. government debt.

That cocktail of factors has increased government bond yields of different maturities, with the U.S. thirty-year Treasury yield climbing above 5 percent and longer-term Japanese government bond yields reaching record levels in May, according to Bloomberg data.  

Higher borrowing costs create constraints for both public and private sectors. For the government, higher interest rates boost the cost of servicing U.S. debt, crowding out available capital for other government priorities and leaving less fiscal room to respond to shocks. For the private sector, higher interest rates on government debt translate into higher borrowing costs for companies and households, the latter importantly including mortgages and auto loans. All else equal, these costs weigh on economic growth.

While less likely, the even greater risk is that investors ultimately view a government’s desire to buy both more guns and butter against the current inflation and fiscal backdrop as a step too far, with a destabilizing rise in bond yields spilling over to other financial markets and weighing more immediately and sharply on the real economy.

It’s understandable that policymakers today want to ensure their constituents feel safe in a less certain world. It’s equally understandable that they want to do what they can to help households navigate the current affordability challenges. However, such desires and related policy proposals need to be considered against central bank and financial market reactions.

As IMF Managing Director Kristalina Georgieva noted in April, such a policy combination in the current fiscal environment could end badly. She compared it to having one foot on the accelerator and one on the brake: “It’s not a good way to drive a car.”

This work represents the views and opinions solely of the author. The Council on Foreign Relations is an independent, nonpartisan membership organization, think tank, and publisher, and takes no institutional positions on matters of policy.