Suppose the real rate of interest on government bonds is 4% and the growth rate of real GDP is 2%.If the government has a positive stock of outstanding debt and its policy objective is to hold the debt-to-GDP ratio constant at its current level,it must

Question

Quizplus · Accepted Answer

In order for the government to hold the debt-to-GDP ratio constant, it must ensure that the growth rate of the debt is equal to the growth rate of GDP. The real interest rate on government bonds is 4%, which means that in order for the debt to grow at a rate of 2%, the government must run a primary budget surplus (revenues exceed expenditures) of at least 2%. Therefore, the correct answer is E – run a primary budget surplus. Running an annually balanced budget or a cyclically balanced budget would not guarantee that the debt-to-GDP ratio remains constant, as it would depend on the level of the deficit or surplus relative to the growth rate of GDP. Eliminating the overall deficit would also not guarantee that the debt-to-GDP ratio remains constant, as it would depend on the level of outstanding debt relative to GDP.

Suppose the Real Rate of Interest on Government Bonds Is