Question

Which of the following generate larger increase in the ratio of debt to GDP? A. A higher rate of output. B. A higher ratio of the primary deficit to GDP. C. A. lower real interest rate D. All of the above. A government has a primary deficit of zero. The real interest rate (r) is 3.5% and the growth rate of output (g) is 5%. The change in the ratio debt to GDP is: A. an inc rease of 1.5% B. an increase of 8.5% C. a decrease of 8.5% D. a dec rease of 1.5%.

Answer 1

Q. 1) Which of the following generate larger increase in the ratio of debt to GDP?

A. A higher rate of output.

B. A higher ratio of the primary deficit to GDP.

C. A. lower real interest rate

D. All of the above.

Correct choice: B) A higher ratio of the primary deficit to GDP

Explanation:

The primary deficit is defined as fiscal deficit minus interest payments.

Thus, it is a measure of government deficit. Now, when the primary deficit is higher, it implies that the debt is also higher. Thus, the debt to GDP ratio will also be higher.

The other options A and C, will both lead to a lower debt to GDP ratio. Higher output means lower debt to GDP ratio, and lower interest rates means lower debt obligations.

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Q. 2) A government has a primary deficit of zero. The real interest rate (r) is 3.5% and the growth rate of output (g) is 5%. The change in the ratio debt to GDP is:

A. an increase of 1.5%

B. an increase of 8.5%

C. a decrease of 8.5%

D. a decrease of 1.5%.

Correct choice: D) a decrease of 1.5%

Explanation:

Primary deficit = Fiscal deficit minus interest payments

Thus, 0 = Fiscal deficit minus interest payments

Fiscal deficit = interest payments

Now, interest payments are growing by 3.5%. GDP is growing by 5%.

Thus the ratio, debt/GDP is growing by (3.5 - 5)% = (-1.5%), a decrease of 1.5%