As the outstanding debt of a nation becomes very large relative to the size of the economy,
A) the borrowing cost of the government will decline.
B) lenders will have no choice but to hold the outstanding bonds and to buy the new ones as they are offered.
C) a country like the United States will have no choice but to default on the payments to bond holders.
D) if the country has a central bank, it will almost certainly resort to money creation to service the debt rather than directly default.

Question

As the outstanding debt of a nation becomes very large relative to the size of the economy,
A) the borrowing cost of the government will decline.
B) lenders will have no choice but to hold the outstanding bonds and  to buy the new ones as they are offered.
C) a country like the United States will have no choice but to default on the payments to bond holders.
D) if the country has a central bank, it will almost certainly resort to money creation to service the debt rather than directly default.

Quizplus · Accepted Answer

When the debt of a nation becomes very large relative to the size of the economy, it becomes more difficult to borrow money, which means that the borrowing cost of the government will increase. However, if the country has a central bank, it can resort to money creation to service the debt, which means that it will print more money and use it to pay off the debt. This can lead to inflation and a decrease in the value of the currency, but it is still preferable to defaulting on the debt directly. Therefore, choice (D) is the best option.

As the Outstanding Debt of a Nation Becomes Very Large