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

A risk analyst models a sovereign with debt at 100% of GDP, an average interest rate of 4%, and nominal GDP growth of 2%. Using the standard approximation (ignoring the 1+g denominator), what primary surplus as a percentage of GDP is needed to keep the debt ratio constant?

A primary surplus of 2% of GDP is required. The stabilizing surplus equals the interest rate minus nominal growth, 4% minus 2%, multiplied by the debt ratio of 100%. Using the interest rate alone would overstate the needed surplus by ignoring the debt-reducing effect of GDP growth.

  1. A1.0%
  2. B2.0%Correct
  3. C4.0%
  4. D6.0%

Explanation

Stabilizing primary balance = (r − g) × debt ratio = (4% − 2%) × 100% = 2% of GDP. Option C uses r alone, which ignores that growth erodes the ratio. Option A would arise from using a wrong debt ratio of 50%.

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