Question

What theory according to krugman’s international economics affect GDP in relation to central government debt?

Answer 1

• Liquidity trap, and, restrictive fiscal policy
• Debt, and, deleveraging

A high ratio of risk to GDP adversely impacts global economic growth, and, risks financial stability. Debt to GDP ratios has risen in the advanced economies.

Areas of emerging risk are:

• A rise in Government debt
• A rise in household debt
• The quadrupling of China's debt owing to shadow banking

Debt is unsustainably high, and, innovation is needed to avoid crises.

Deleveraging requires fiscal adjustments, and, increases in real GDP growth. Debt rose as a result of weak recovery, recession, stimulus programs, bailouts. The approaches to reducing Government debt may be one time taxes on wealth; extensive asset sales, and, debt restructuring programs.

High debt may also arise when the economy moves out of the liquidity trap. If private demand is high, central bank raises the interest rate to increase inflation. The demand shifts the aggregate demand curve, and, raises the short-term interest rate, and, the yield on long-term Government bonds. Government's interest payments increase with time. In case of high public debt to GDP ratio payments are high relative to tax revenues. Thus, the composition of Government liabilities between monetary base, and, bonds matters in the non-liquidity trap times; the interest payments are on the bonds in Government liabilities.