Suppose that the country of Aquilonia has an inflation rate of about 2 percent per year and a real growth rate of about 1 percent per year. Suppose also that it has nominal GDP of about 200 billion units of currency and current nominal national debt of 150 billion units of domestic currency. Which of the following government spending and taxation figures will not raise the debt-to-income ratio?

Question

Quizplus · Accepted Answer

The debt-to-income ratio will not increase if the deficit (government spending minus tax collections) is less than or equal to the growth of nominal GDP. With a nominal GDP growth rate of 3% (2% inflation + 1% real growth), the GDP will increase by 6 billion units (3% of 200 billion). In option A, the deficit is 4 billion (20 - 16), which is less than the 6 billion increase in GDP, so the debt-to-income ratio will not rise.

Suppose That the Country of Aquilonia Has an Inflation Rate