BR15A: Bridge: Deficits and National Debt
Question 1
The government of Happyland collects \$100 million in taxes each year and currently has a public debt of \$1.2 billion, which it finances by issuing Treasury bonds that pay 8% per year. Is this a manageable level of debt for the government of Happyland?
A. Yes, the debt is manageable because the public debt is only 12 times the size of tax revenues.
B. No, the debt is not manageable because interest payments equal \$96 million per year.
C. No, the debt is not manageable because the government must repay the entire \$1.2 billion debt at the end of the year.
D. Yes, the debt is manageable because an interest rate of 8% is relatively low.
Hint
The government must at least service the debt—pay interest on its outstanding loans and principal on its maturing loans—to remain in compliance with its debt obligations.Answer
B. No, the debt is not manageable because interest payments equal \$96 million per year. Annual interest payments on the debt are$$0.08 \times \$1{,}200{,}000{,}000 = $96{,}000{,}000$$
While it is possible to cover interest on the debt with \$100 million in tax revenues, that would leave just 4% $\left(\frac{$4{,}000{,}000}{$100{,}000{,}000} \times100 \right)$ of tax revenues to pay the principal on maturing loans and all other government expenditures (assuming no additional debt is incurred). This is not a manageable level of debt.
Question 2
Which of the following best describes a country’s external debt?
A. It is the portion of the total national debt that is financed by foreign bondholders.
B. It is the portion of the public debt financed by foreign bondholders.
C. It is the portion of the public debt financed by domestic bondholders.
D. It is the portion of the annual fiscal deficit financed by foreign bondholders.
Hint
Think big here, not just of the debt owed by any specific economic agents.Answer
A. It is the portion of the total national debt that is financed by foreign bondholders. External debt is the total debt owed by the government, firms, and citizens of a country to foreign creditors. Portions of the external debt may be owed to private banks, other governments, and international financial institutions such as the International Monetary Fund (IMF) and World Bank.Question 3
Suppose a country is projecting a deficit of \$20 million next year. Which of the following events would add most to the debt?
A. an increase in the deficit of \$500,000
B. a 3% rise in the interest rate
C. an increase in tax revenues of \$600,000
D. all of the above would increase the debt by the same amount
Hint
Interest must be paid on the debt. Thus, be sure to calculate the additional debt generated when the interest rate is at the level given in the question.Answer
B. a 3% rise in the interest rate A 3% increase in the interest rate would add \$600,000 (\$20,000,000 x 0.03) to the deficit and thus to the debt. This exceeds a \$500,000 increase in the deficit, while tax revenues would decrease, not increase, the debt.Question 4
South World has a total debt of \$10 million and an annual GDP of \$5 million. It currently pays 4% interest on its debt every year. What percentage of annual GDP does interest on the debt represent?
A. 4%
B. 8%
C. 50%
D. 15%
Hint
The first step is to find the dollar value of the interest paid every year on the debt.Answer
B. 8% The annual interest on the \$10 million debt is, \$10 million x 0.04 = \$400,000.\$400,000 is 8% of the annual GDP of \$5 million.
$\frac{\$400000}{\$5000000}=0.08$
Question 5
If Northland has a debt of \$5 million in 2014, and runs a deficit of \$0.3 million in 2015, and a surplus of \$0.4 million in 2016, what would its debt be at the end of 2016, assuming no additional interest is added to its debt?
A. \$4.3 million
B. \$5.3 million
C. \$4.9 million
D. \$5.7 million