11.2Sustainable level of government debt (HL Only)

Sustainable level of government debt

• A Budget deficit exists when the value of government expenditure exceeds government revenue in a given time period
• Government debt (national debt) is the sum of all accumulated budget deficits from previous years, which is the money owed to creditors. This is usually expressed as a percentage of the country’s GDP.
  • owed 欠钱
  • creditor 债权人
  • Government = Debtor（债务人）
  • Bond holder = Creditor（债权人）, 买 G bonds的人
• While it is reasonable for a government to borrow money in certain contexts, an excessive level of debt has negative implications. A sustainable level of government debt is more desirable

Measurement of government debt

• The debt to GDP ratio reflects the country’s government debt as a percentage of its GDP.

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Costs of government debt

• Debt servicing costs
  • Debt servicing costs refers to the costs of financing debt, which is the sum of the principal amount and interest paid. The larger the government debt, the higher the interest payments, and the greater the debt servicing cost.
• Credit ratings
  • Credit ratings measure a debtor’s ability to repay debt. A party with a higher credit rating is has a greater ability to repay their loans and thus have a higher chance to secure loan capital from financial institutions. Countries with greater existing debts tend to have poorer credit ratings.
    • •Borrower’s past credit record
    • •Amount of money borrowed
    • •Amount of existing loans
    • •Income of the borrower.
• Impact on future taxation and government spending
  • National debts must be financed by future budget surpluses, where government revenue exceeds government spending.
  • Austerity measures refer to policies used to reduce government debt, such as increasing tax and/or reduce spending.

Budget deficit and government debt

• A budget deficit exists when governments spending exceeds government revenue. The underlying assumption is that tax is the only source of government revenue, e.g., income tax, corporate tax, VAT, and tariffs.
• Budget deficits can be beneficial in the short term as it means that more money is injected into the circular flow of income, boosting economic growth and creating jobs. This is particularly useful in the event of a deep recession where the economy requires intervention
• In the long term, however, budget deficits are unsustainable. Due to debt interests, the government debt will increase exponentially if it is not repaid
• The government cannot run a budget deficit indefinitely. It must pay off the debt by reducing its spending or by raising its tax revenue. The government debt must be balanced by budget surpluses.