Question

Q18

Consider changes in the government's debt-to-GDP ratio (G/GDP). If the rate of interest on government debt is ________ the growth rate of GDP, a primary budget __________ will _______

Question 18 options:

	less than; surplus; always reduce the D/GDP ratio.
	less than; deficit; increase or decrease the D/GDP ratio.
	greater than; deficit; always increase the D/GDP ratios.
	equals; balance; not change the D/GDP ratio.
	All of the above.

Answer 1

Answer to the question no. 18:

Option e: All of the above.
Explanation: D(Debt / GDP) = (G - T) / GDP + {i - [(D GDP ) / GDP]} (Debt/GDP)

In the above formula:

D(Debt / GDP)= growth rate of Debt-to-GDP

(G - T )= Primary budget deficit

i= interest on government borrowing.

D GDP= groth rate of GDP.

The formula tells us that the Debt-to-GDP ratio will rise if there is primary deficit (G-T) and if the interest rate on national debt is greater than the GDP growth rate. Primary deficit always adds to the national debt. On the onther hand, a positive difference between interest rate and GDP growth rate means that the interest rate is causing the Debt to rise faster than the GDP, thus causing the Dept-to-GDP to rise.

Similarly, the formula tells us that the Debt-to-GDP ratio will fall if there is primary budget surplus and if the interest rate on national debt is lesser than the GDP growth rate.

Again, the Debt-to-GDP ratio may rise or fall if there is primary budget deficit and if the interest rate on national debt is lesser than the GDP growth rate. Here, GDP growth will cause the debt-to-gdp to fall as the GDP growth rate is higher than the interest rate. But, primary deficit will be causing the debt-to-gdp to rise. If the rate of increase in the debt-to-gdp (because of the primary deficit) is higher than the rate of reduction in the debt-to-gdp (because of the fact that rate of interest < GDP growth rate) the overall Debt-to-GDP will increase. And will fall otherwise.

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