Question

A recent report on GDP growth rates showed that the GDP of​ Dorada, a developed​ economy, has declined by 1.5 percent this year. Emily George and her friend Tabitha​ Jude, both students of​ economics, are discussing the possible reasons for the decline in the growth rate. Emily feels that the government deficit has reached an unsustainable​ level, as a result of which interest rates now are extremely high. This has reduced government expenditure in recent​ times, leading to a decline in GDP. Tabitha however disagrees. According to​ her, the fall in GDP must imply a fall in consumer spending as household consumption accounts for the largest share in​ Dorada's GDP. Which of the​ following, if​ true, will strengthen​ Emily's claim that the high fiscal deficit is affecting the​ government's ability to​ spend?

A.

The government of Dorada scaled up its defense expenditure by more than 50 percent in the last two years.

B.

The​ President's economic advisory council is of the opinion that the fiscal deficit should not exceed 3 percent of the​ country's GDP.

C.

The central​ government's grants-in-aid to the local governments increased by 7 percent.

D.

A sizeable portion of the tax revenue generated in Dorada is being used to make interest payments on sovereign debt.

E.

Given that the government of Dorada has never defaulted on sovereign​ debt, it enjoys very high credit ratings.

Answer 1

Emily has stated that decline in GDP has happened because of reduction in government expenditures in recent times.

When government reduces its expenditure in drastic manner then this impllies that government is able to spend a small portion of its tax revenue for developmental purpose and large portion of its tax revenue is being spent on non-developmental expenditures like interest payments etc.

When government has high level of debt then significant portion of its tax revenue goes in servicing such debt and thus its ability to undertake expenditure for economic development gets greatly reduced.

Similar thing has happened in Dorada as well.

So,

The argument that will strengthen the Emily's claim is that a sizeable portion of the tax revenue generated in Dorada is being used to make interest payments on sovereign debt.

Hence, the correct answer is the option (D).