Debt to GDP ratio definition
The debt to GDP ratio measures a nations’ government debt divided by the country’s GDP. Levels of Debt to GDP ratios above 80% indicate a weak economy.
Debt to GDP
A government can boost economic activity by running a government deficit. A government deficit occurs when the government spends more that it receives from tax revenues. The remainder of funds is borrowed by issuing government debt. Government debt can be bought by investors or the government itself which prints money and purchases its own debt. The latter option is only available for reserve currency countries like the US which are allowed to issue debt in their own currency.
A country’s outstanding debt is repaid by 1. gradually inflating it away, 2. restructure it, 3. Default on it or 4. Debt monetize it. Debt monetization a monetary policy tool in which the country’s central bank prints money and purchases its own government debt.
Most countries, use monetary policy and fiscal policy tools to bring inflation higher than nominal interest rates and gradually repay debt. This however is inflationary and leads to short currency bias. Hence, countries with high outstanding debt have a tendency to weaken their currency.
A country’s outstanding debt is measured as a percentage of GDP. Higher debt to GDP ratios indicate an economy which is more dependent on government spending. The debt to GDP ratio can be reduced if GDP increases by more than the level of government spending.
Debt to GDP levels of 80% indicate a weakening economy while debt to GDP ratios of 100% indicate countries in crisis.
The United States has a Debt to GDP ratio of 120%. The US can sustain such high levels of Debt to GDP since it has the world’s largest reserve currency. However, the central bank has no choice but to keep interest rates low and increase the money supply in order to keep inflation higher than nominal interest rates to gradually repay it by inflating it away.