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

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Quizplus · Accepted Answer

To hold debt-to-GDP ratio constant, the primary deficit (difference between revenue and non-interest expenditure) must be equal to the product of real interest rate and outstanding debt divided by real GDP growth rate. In this case, primary deficit = 0.04*0.3/0.02 = 0.6 or 0.6% of GDP. Therefore, the government must run a primary budget surplus of 0.6% of GDP.

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