Question

Economists at the Reserve Bank of Australia (Australia's central bank) forecast that between 2020 and 2040 the country's nominal GDP will grow by 5% each year. They also predict that the country's debt will grow by 6% between 2020 and 2030 and then will remain unchanged between 2030 and 2040. What do these predictions imply for Australia's debt-to-GDP ratio in 2030 and 2040?

Answer 1

A country's debt to gdp ratio is the ratio of how much debt the country has with reseoct to how much goods and services it is able to porduce and sell in the economy.

In this case, since the debt to gdp ratio rises from 2020 - 2030, it means that during this decade, the Australian economy is not able to produce and sell enough goods and services domestically to offset the debt, the the government debt is increasing. This happens when there is not enough income generated in the economy and hence the revenue collected by the government is not enough to meet all the transfer payment schemes of the government like pensions, cash transfers, or even defence expenditure. The government thus has to borrow from internal or external sources , which increase the debt.

During the years 2030 - 2040, the government debt remains constant, which means whatever the economy is able to porduce is enough to fulfill the government's need for resources and hence the government does not have to borrow. Duirng this decade, there is no further accumulation of debt, but there is also no reduction of debt. It means that the economy is producing goods and services just enough to fulfill the needs and not more to enable repayment of the debt. Since the growth rate of the GDP has remained the same, it means that there was either reduction in the population, or there were targetted efforts by the government to reduce spending in areas that were not directly adding to the country's growth. By doing this, the government will be prevented from incurring more debt, and the debt to gdp ratio will remain the same.