Question

Suppose the following statistics characterize the financial health of the hypothetical economy Spendia at the end of 2017:

•	Gross domestic product (GDP) is equal to $100 billion.
•	The national debt is equal to $120 billion.
•	The government has a budget deficit of $9 billion.
•	The debt ceiling in Spendia is set at $139 billion.

The following calculations help you see how the ratio of debt to GDP changes from one year to the next.

Complete the first row of the following table by computing the ratio of national debt to GDP.

Suppose that nominal GDP remains at $100 billion in 2018, and again the government runs a budget deficit of $9 billion. For simplicity, assume the interest rate on the national debt is 0%, and no payments are being made to reduce the debt.

Calculate national debt and the debt-to-GDP ratio in 2018. Enter these values in the second row of the following table.

Year	GDP	National Debt	Ratio of National Debt to GDP
	(Billions of dollars)	(Billions of dollars)
2017	100	120
2018	100

Now that the government’s national debt has been growing for several years, investors have become worried that the government might default on its debt—that is, might refuse to pay back the investors. As a result, the investors are now willing to lend to the government only if they receive an interest rate of 20%.

If the government runs a budget deficit of $10 billion in 2019, the national debt will increase by

billion.

True or False: At the end of 2019, the government of Spendia will exceed the legal limit on how much it can borrow.

True

False

Answer 1