3.3.6 Sustainable level of government (national) debt (HL only) Notes

1. Two key macroeconomic concepts that affect every economy are government debt and its sustainability.
2. A sustainable debt level enables governments to meet their financial obligations without undermining economic stability or future growth.

Measurement of Government (National) Debt as a Percentage of GDP

1. This measurement shows the debt burden relative to the economy’s size.
2. It enables international comparisons.
3. Moreover, it indicates a country’s ability to repay debt.

$$\text{GDP Deflator} = \frac{\text{Nominal GDP}}{\text{Real GDP}} \times 100$$

Relationship between a budget deficit and government (national) debt

1. Understanding how budget deficits contribute to national debt is crucial, as it creates a cycle of borrowing and accumulation.
2. Budget deficits accumulate as debt:
   1. When the government spends more than it collects (deficit), it must borrow to cover the gap.
   2. This borrowing is added to the existing national debt.
   3. Continuous deficits lead to continuous borrowing, causing debt to rise each year.

1. Debt has a compounding nature:
   1. Each borrowed amount requires interest payments.
   2. These interest payments become part of the next year’s expenses.
   3. New deficits require additional borrowing on top of existing debt.
2. This creates a “snowball effect” where:
   1. Interest payments grow larger.
   2. More borrowing may be needed just to pay interest.
   3. Debt can increase even if the original deficit remains constant.

Costs of a high government (national) debt

High government debt creates three interconnected problems that can spiral into a cycle of economic challenges.

1. Debt Servicing Costs
   1. Government must pay interest on borrowed money.
   2. A significant portion of tax revenue goes to interest payments.
   3. Less money remains for schools, healthcare, and infrastructure.
   4. Higher interest rates make this burden even heavier.
2. Credit Ratings
   1. High debt damages a government’s creditworthiness.
   2. Lower credit ratings → higher interest rates.
   3. Borrowing becomes more expensive, creating a spiral of rising costs.
3. Impacts on Future Taxation and Spending
   1. Future governments have less spending flexibility.
   2. They may need to raise taxes to repay old debts.