Take a country that has the debt-to-GDP ratio equal to bo. Suppose the real interest rate on government bonds is larger than the rateof growth of real GDP. Suppose further that the government is running a primary deficit, so that the debt ratio is bound to increase.Now suppose the government takes measures to stabilize debt and starts running a primary surplus large enough to keep thedebt ratio constant. Show on the debt dynamics graph how this change in fiscal policy makes the government able to maintain debtat bo-a)b)Now assume that the sharp fiscal contraction leads to a recession, decreasing the growth rate of real GDP. Using the debtdynamics equation and assuming that the growth rates and primary surpluses are negatively correlated, explain the impact of a fiscalcontraction on the subsequent stabilization of the debt-to-GDP ratio.

Gross Domestic Product (GDP) is defined as the monetary value of all the final goods and services…

Take a country that has the debt-to-GDP ratio equal to bo. Suppose the real interest rate on government bonds is larger than the rate of growth of real GDP. Suppose further that the government is running a primary deficit, so that the debt ratio is bound to increase.

Take a country that has the debt-to-GDP ratio equal to bo. Suppose the real interest rate on government bonds is larger than the rate of growth of real GDP. Suppose further that the government is running a primary deficit, so that the debt ratio is bound to increase.

Exploring Economics

8th Edition

ISBN:9781544336329

Author:Robert L. Sexton

Publisher:Robert L. Sexton

Chapter24: Fiscal Policy

Section: Chapter Questions

Problem 5P

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Question

Take a country that has the debt-to-GDP ratio equal to bo. Suppose the real interest rate on government bonds is larger than the rate
of growth of real GDP. Suppose further that the government is running a primary deficit, so that the debt ratio is bound to increase.
Now suppose the government takes measures to stabilize debt and starts running a primary surplus large enough to keep the
debt ratio constant. Show on the debt dynamics graph how this change in fiscal policy makes the government able to maintain debt
at bo-
a)
b)
Now assume that the sharp fiscal contraction leads to a recession, decreasing the growth rate of real GDP. Using the debt
dynamics equation and assuming that the growth rates and primary surpluses are negatively correlated, explain the impact of a fiscal
contraction on the subsequent stabilization of the debt-to-GDP ratio.

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