CFA Level I · CFA Level I Exam · Fiscal Policy
An economy has a debt-to-GDP ratio of 80%. Nominal GDP is growing at 4% a year and the government pays an average interest rate of 3% on its debt. To keep the debt-to-GDP ratio constant, the government is most likely required to run a primary:
The government can run a primary deficit of about 0.8% of GDP. Because growth of 4% exceeds the 3% interest rate, the debt ratio shrinks on its own, and the required primary balance is (3% - 4%) times 80%, or -0.8% of GDP.
- ADeficit of about 0.8% of GDPCorrect
- BBalance of zero
- CSurplus of about 0.8% of GDP
Explanation
Stabilizing debt requires a primary balance of (r - g) x debt ratio = (3% - 4%) x 80% = -0.8% of GDP. A negative value means a primary deficit of 0.8% of GDP is consistent with a constant ratio. A surplus would apply only if the interest rate exceeded growth.
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