Question

6. i) Do countries with a big public debt are more likely to have eventually an unsustainable public debt? ii) Explain the difference between budget deficit and primary budget deficit. iii) Under which conditions the public debt can turn unsustainable? iv) Why the public DEBT of the PIIGS turned unsustainable?

Answer 1

(I) Countries with a big public debt are more likely to have eventually an unsustainable public debt.When the government borrows a huge amount of money from the public it will lead to huge public debt and the public debt is calculated as a percentage of GDP.If the public debt increases beyond a threshold limit then it will lead to unsustainable public debt. Unsustainable debt refers to the situation where the cost of maintaining public debt is very high and the incoming revenues of the government are not enough to service the debt.It will lead to slow down of the economy and the fiscal deficit will increase.

ii)The difference between the total receipts of the country and total expenditure of the country is known as the budget deficit.Primary deficit is the borrowings minus interest payments.Interest payments are not included in the primary deficits.

iii)When the government borrows from the public beyond a threshold limit it will lead to huge fiscal deficits in the economy.High public debt of an economy will also crowd out the private investments and the risk of sovereign insolvency will also increase that is the risk of repaying the debt will increase .Higher debt will lead to unsustainable fiscal policies in the economy.All these factors will result in the slow growth of economy and eventually the public debt turns unsustainable.

iv)Portugal ,Italy,Ireland,Greece and Spain (PIIGS) are known as the weakest economies of Eurozone.The main reason for the public debt of PIIGS turned unsustainable was due to U.S financial crisis in 2008.The financial crisis in 2008 forced PIIGS to borrow huge amounts from public.The global financial crisis of 2008 created a negative shock in PIIGS and they were incapable paying back the amount they borrowed.This led to high level of unemployment,huge debt ratios and slow economic progress and GDP growth in these weaker economies and thus their public debt turned unsustainable.