Debt-to-GDP ratio

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In economics, particularly macroeconomics, various debt-to-GDP ratios can be calculated. The most commonly used ratio is the Government debt divided by the Gross Domestic Product (GDP), which reflects the government's finances, while another common ratio is the total debt to GDP, which reflects the nation as a whole's finance.

Contents 1 Units 2 Changes 3 Applications 4 Notes 5 References 6 See also

[edit] Units

It is generally expressed as a percentage, but properly, has units of years, as below.

By dimensional analysis these quantities are the ratio of a stock (with dimensions of Currency) by a flow (with dimensions of Currency/Time), so^{[note 1]} they have dimensions of Time. With currency units of US Dollars (or any other currency) and time units of years (GDP per annum), this yields the ratio as having units of years, which can be interpreted as "the number of years to pay off debt, if all of GDP is devoted to debt repayment". This interpretation must be tempered by the understanding that GDP cannot be all devoted to debt repayment – some must be spent on survival, at the minimum, and in general only 5–10% will be devoted to debt repayment, even during episodes such as the Great depression, which have been interpreted as debt-deflation – and thus actual "years to repay" is debt-to-GDP divided by "fraction of GDP devoted to repayment", which will generally be 10 times as long or more than simple debt-to-GDP.

[edit] Changes

The change in debt-to-GDP is approximately "net increase or (decrease) in debt as percentage of GDP"; for government debt, this is deficit or (surplus) as percentage of GDP.

This is only approximate, as GDP changes from year to year, but generally year-on-year GDP changes are small (say, 3%), and thus this is approximately correct.

However, in the presence of significant inflation, deflation, or particularly hyperinflation, GDP may increase rapidly in nominal terms; if debt is nominal, then it will decrease rapidly.

[edit] Applications

Debt-to-GDP measures financial leverage of an economy; some economists, such as Steve Keen, advocate using it as the key measure of a credit bubble (both its level and its change), and high levels of government debt are widely decried as fiscal irresponsibility.

One of the Euro convergence criteria was that government debt-to-GDP be below 60%.

World Bank and IMF hold that “a country can be said to achieve external debt sustainability if it can meet its current and future external debt service obligations in full, without recourse to debt rescheduling or the accumulation of arrears and without compromising growth.” According to these two institutions, external debt sustainability can be obtained by a country “by bringing the net present value (NPV) of external public debt down to about 150 percent of a country’s exports or 250 percent of a country’s revenues.” [1] High external debt is believed to have harmful effects on an economy.^[1]

[edit] Notes

[edit] References

[edit] See also

• Credit bubble
• Leverage (finance)
• List of countries by public debt

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