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FRM Part II · FRM Exam Part II · Monetary and Fiscal Policy: Safeguarding Stability and Trust

A country has debt at 90% of GDP, an average interest rate of 4%, nominal GDP growth of 3%, and a primary balance of zero. Ignoring other flows, approximately what primary surplus as a percent of GDP is needed to keep the debt ratio stable?

A primary surplus of about 0.9% of GDP is needed. The debt-stabilizing primary balance equals the gap between the interest rate and nominal growth, 1 percentage point, multiplied by the debt ratio of 90%. Using only the interest rate or only the growth rate would overstate the requirement.

  1. A0.9% of GDPCorrect
  2. B1.0% of GDP
  3. C3.6% of GDP
  4. D2.7% of GDP

Explanation

Stabilizing primary balance = (r - g) x debt ratio = (4% - 3%) x 90% = 0.9% of GDP. Using r alone gives 3.6%, and using g alone gives 2.7%; both ignore the interest-growth differential. 1.0% would be (r-g) without the debt ratio.

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