Unlike households, governments are often able to sustain large debts. For example, in September 2007, the U.S. govern- ment’s total debt reached $9 trillion, approximately 64% of GDP. At the time, according to the U.S. Treasury, the average interest rate paid by the government on its debt was 5.0%. However, running budget deficits becomes hard when very large debts are outstanding.
a. Calculate the dollar cost of the annual interest on the government’s total debt assuming the interest rate and debt figures cited above.
b. If the government operates on a balanced budget before interest payments are taken into account, at what rate must GDP grow in order for the debt–GDP ratio to remain un- changed?
c.Calculate the total increase in national debt if the government incurs a deficit of $200 billion in 2008. Assume that the only other change to the government’s total debt arises from interest payments on the current debt of $9 trillion.
d. At what rate must GDP grow in order for the debt–GDP ratio to remain unchanged when the deficit in 2008 is $200 billion?
e. Why is the debt–GDP ratio the preferred measure of a country’s debt rather than the dollar value of the debt? Why is it important for a government to keep this number under control?
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