Question

what are two reasons of when debt becomes a problem for a country?

Answer 1

Governments have a tendency to take on excessive debt since the advantages make them popular with electors. Thus, investors normally gauge the risk level by comparing debt to a nation's overall economic output, known as GDP. The debt-to-GDP ratio provides a signal of how likely the nation can repay its debt. Investors normally do not become concerned till the debt-to-GDP ratio attains a critical level.

Whilst it appears the debt is reaching a critical level, investors normally begin to demand a greater interest rate. They desire more return for the greater risk. If the nation keeps spending, then its bonds may obtain a lower S&P rating. This denotes how probable it is the nation will default on its debt.

As interest rates increase, it becomes more costly for a nation to refinance its prevailing debt. Eventually , more income has to go towards the repayment of the debt, & less towards a governmental services. Much like what happened in Europe, a case like this could cause a sovereign debt crisis.

In the long-term, public debt which is too big can be like chauffeuring with the emergency brake on. Investors escalate interest rates in return for higher risk of default. This makes the elements of economic expansion, like corporate growth, housing & auto loans, costlier. To avert this burden, authorities must be prudent to find that optimal level of public debt. It must be big enough to propel economic growth but sufficiently small to keep interest rates low.