Question

In which of the following situations does the government NOT need to balance its budget? a. if nominal GDP grows faster than the growth in debt b. if nominal GDP grows slower than the growth in debt c. if inflation is zero d. if inflation is higher than the growth in debt

Answer 1

Correct choice is option C

If nominal GDP has a higher growth rate than the growth rate of debt tax revenue increases by more than the increase in expenditure so that budget is in surplus. Similarly when nominal GDP has a lower growth rate than the growth rate of debt, tax revenue increases by less than the increase in expenditure budget is in deficit. When inflation is zero nominal interest rate and real interest rate are equal to each other. This indicates that increase in debt will be equal to the increase in nominal growth rate.