Question

1. Discuss disadvantages of having large amount of government debt.

2. (A) Calculate the amount of money you will have in your account after 6 years if you put in $7,000 now at 5% of interest rate. Use compounding.

   (B) What is present value of $10,000 after 5 years at 6% of interest rate? Use compounding.

    (C) Say, you are an investor between stocks and bonds. In which one will you invest when interest rates go up? Explain.

Answer 1

1)

Rising government debt implies that government does not have enough revenue to fund its expenditures. Debt could be right option during the recession when demand is abysmally low, so government expenditure funded through the debt could cause rise in demand and output. But if debt rises even during the period of boom, it could suggest imminent crisis in country. Following are disadvantages:

• Debt if used for unproductive purposes, it leads to burden on future generation. Thus debt must be used for productive economic activities.
• Debt raises interest rate in market, and causes crowding out effect by decreasing private investment.
• Debt discourage foreign direct investment.
• Even domestic investors do not show interest in investment projects fearing future returns might be compromised.
• High Debt causes inflation.

US debt has increased to $ 22 trillion which is 108 % of GDP, US debt must be controlled, so that government keeps the sufficient leeway to control potential crisis in future. Debt must be avoided if politically motivated activities drive up debt level.