Suppose the government's objective is to hold its debt-to-GDP ratio constant at its current level of 30%.If the real interest rate on government bonds is 4% and the growth rate of real GDP is 2%,the government must

Question

Quizplus · Accepted Answer

To hold its debt-to-GDP ratio constant at 30%, the government would need to match its primary budget deficit (the budget deficit excluding interest payments) with the interest payments on its debt. In this case, the real interest rate on government bonds is 4%, so the government would need to run a primary budget surplus of 4% - 2% (the difference between the interest rate and real GDP growth) = 2% of GDP. Since the government's current debt-to-GDP ratio is 30%, its overall budget deficit would need to be reduced by 30% / 2% = 15% of GDP to achieve this primary budget surplus. Therefore, the government would need to run a primary budget surplus of 0.6% of GDP (0.02 x 0.3 = 0.006) to hold its debt-to-GDP ratio constant. This means that the correct choice is D.

Suppose the Government's Objective Is to Hold Its Debt-To-GDP Ratio