FRM Part II · FRM Exam Part II · Monetary and Fiscal Policy: Safeguarding Stability and Trust
A government's debt is USD 800 billion and nominal GDP is USD 1,000 billion. The average interest rate on debt is 3% and rises to 5% after refinancing. Ignoring primary balance and growth, by how many percentage points of GDP does annual interest cost increase?
With debt at 80% of GDP, interest cost moves from 2.4% to 4.0% of GDP when the average rate rises from 3% to 5%. The increase is therefore 1.6 percentage points of GDP per year.
- A1.6Correct
- B2.0
- C0.8
- D4.0
Explanation
Debt-to-GDP is 80%. Interest cost rises from 0.8 x 3% = 2.4% of GDP to 0.8 x 5% = 4.0% of GDP, an increase of 1.6 points. The 2.0 figure applies the rate change to 100% of GDP; 0.8 is the debt ratio itself; 4.0 is the new total cost.
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