Debt to GDP ratio - AbsoluteAstronomy.com

Economics

Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...

, the debt-to-GDP ratio is one of the indicators of the health of an economy.
It is the amount of national debt of a country as a percentage of its Gross Domestic Product (GDP).
A low debt-to-GDP ratio indicates an economy that produces a large number of goods and services and probably profits that are high enough to pay back debts. Governments aim for low debt-to-GDP ratios and can stand-up to the risks involved by increasing debt as their economies have a higher GDP and profit margin. According to the CIA World Factbook, the 2010 public debt-to-GDP ratio

United States public debt

The United States public debt is the money borrowed by the federal government of the United States at any one time through the issue of securities by the Treasury and other federal government agencies...

in the US was 62.3% with a gross debt-to-GDP ratio of about 92.3%. The level of public debt in Japan in 2010 was 225.8% of GDP. The level of public debt in Germany in the same year was 78.8% of
GDP.

Particularly in macroeconomics

Macroeconomics

Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of the whole economy. This includes a national, regional, or global economy...

, various debt-to-GDP ratios can be calculated. The most commonly used ratio is the Government debt

Government debt

Government debt is money owed by a central government. In the US, "government debt" may also refer to the debt of a municipal or local government...

divided by the Gross Domestic Product

Gross domestic product

Gross domestic product refers to the market value of all final goods and services produced within a country in a given period. GDP per capita is often considered an indicator of a country's standard of living....

(GDP), which reflects the government's finances, while another common ratio is the total debt to GDP, which reflects the finances of the nation as a whole.

Units

The debt-to-GDP ratio is generally expressed as a percentage, but properly, has units of years, as below.

By dimensional analysis

Dimensional analysis

In physics and all science, dimensional analysis is a tool to find or check relations among physical quantities by using their dimensions. The dimension of a physical quantity is the combination of the basic physical dimensions which describe it; for example, speed has the dimension length per...

these quantities are the ratio of a stock (with dimensions of Currency) by a flow (with dimensions of Currency/Time), soCurrency/(Currency/Time) = Time 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

Great Depression

The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...

, 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.

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

Economic surplus

In mainstream economics, economic surplus refers to two related quantities. Consumer surplus or consumers' surplus is the monetary gain obtained by consumers because they are able to purchase a product for a price that is less than the highest price that they would be willing to pay...

) 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

Inflation

In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...

, deflation, or particularly hyperinflation

Hyperinflation

In economics, hyperinflation is inflation that is very high or out of control. While the real values of the specific economic items generally stay the same in terms of relatively stable foreign currencies, in hyperinflationary conditions the general price level within a specific economy increases...

, GDP may increase rapidly in nominal terms; if debt is nominal, then it will decrease rapidly.

Applications

Debt-to-GDP measures the financial leverage of an economy; some economists, such as Steve Keen

Steve Keen

Steve Keen is a Professor in economics and finance at the University of Western Sydney. He classes himself as a post-Keynesian, criticizing both modern neoclassical economics and Marxian economics as inconsistent, unscientific and empirically unsupported...

, advocate using it as the key measure of a credit bubble (both its level and its change – particularly of private debt and total debt), and high levels of government debt (public 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.” http://www.internationalmonetaryfund.com/external/np/hipc/2001/lt/042001.pdf High external debt is believed to have harmful effects on an economy.

There is difference between external debt nominated in domestic currency, and external debt nominated in foreign currency. A nation can service external debt nominated in domestic currency by tax revenues, but to service foreign currency debt it has to convert tax revenues in foreign exchange market to foreign currency, which puts downward pressure on the value of its currency. So all of the money used to service foreign currency debt has to come from a country's balance of payments

Balance of payments

Balance of payments accounts are an accounting record of all monetary transactions between a country and the rest of the world.These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers...

transfers.

Units

Changes

Applications

See also