Question

In considering a country’s budget deficit and debt:

(a) What is the relationship between the deficit and the debt?

(b) why is the debt to GDP ratio important?

(c)what factors cause change in the debt to GDP ratio?

Answer 1

(a). A budget deficit occurs when spending is greater than the revenue received in that year. When spending exceeds revenue, it's called deficit spending. The national debt is the accumulation of each year's deficit.When revenue exceeds spending, it creates a budget surplus. A surplus reduces the debt.

Deficit can very well be innocuous or benign – at least, at the national level. Even when compared to a surplus. Debt is inevitable, given that an economy can’t really function without borrowers and lenders. The magnitude of each doesn’t necessarily have anything to do with the other, but has plenty to do with the size of the underlying economy. Debt is the accumulation of years of deficit (and the occasional surplus.)

(b) .The debt-to-GDP ratio is the ratio of a country's public debt to its gross domestic product (GDP). By comparing what a country owes with what it produces, the debt-to-GDP ratio indicates its ability to pay back its debts. Often expressed as a percentage, this ratio can also be interpreted as the number of years needed to pay back debt if GDP is dedicated entirely to debt repayment.

Debt to GDP ratio is important because,If a country is unable to pay its debt, it defaults, which could cause a financial panic in the domestic and international markets. The higher the debt-to-GDP ratio, the less likely the country will pay back its debt and the higher its risk of default.

(c). The change in debt-to-GDP is approximately "net change in debt as percentage of GDP"for government debt, this is deficit or (surplus) as percentage of GDP.However, in the presence of significant inflation, or particularly hyperinflation, GDP may increase rapidly in nominal terms; if debt is nominal, then its ratio to GDP will decrease rapidly. A period of deflation would have the opposite effect.