Debt-to-GDP ratio - Wikipedia
addresses the issue of break effects between government debt and . assumes a linear relationship between debt-to-GDP and growth. Yt = α +. The relationship between public debt expansion and economic growth has attracted a lot of interest in recent years, spurred by the sharp. Most countries around the world rely on sovereign debt to finance their The debt-to-GDP ratio is a commonly used term among rating.
This is sometimes known as default through inflation. If investors fear inflation, they may sell bonds, causing interest rates to rise. Higher inflation will lead to higher bond yields as investors demand higher interest rates to protect against the falling value of nominal bonds.
Why higher debt levels do not lead to higher bond yields However, although this is a possibility, it rarely occurs amongst developed Western economies. Risk of default very minimal. It is rare for a developed economy to default on government debt.
Countries like the UK and US have not suffered an outright debt default in their history. Lender of last resort. For countries with their own currency let us ignore Eurozone economies for the momentthe Central Bank can always step in and purchase government debt. If necessary the Central Bank could create money in order to purchase government bonds. This helps avoid any liquidity fears markets may have.
Debt and economic cycle. During a recession, government debt tends to rise. This is due to cyclical factors, such as a fall in income tax revenue and higher welfare spending. This leads to higher debt, but in a recession, the private saving ratio tends to rise. There is greater demand for buying government bonds in a recession because people are looking for a safe haven for their excess savings. Therefore, bond yields tend to fall during a recession — because there is greater demand for buying bonds.
When the economy recovers, savers start to look for more profitable uses for their savings e. Furthermore, in a recession, the base rate will be cut. This tends to reduce all interest rates in the economy, including bond yields. Budget deficit From — net debt is rising, but there is a fall in the annual borrowing requirement In addition to net public sector debt total debtit is worth looking at the annual budget deficit.
For example, the UK government will claim that their austerity measures to reduce the budget deficit are responsible for the fall in UK bond yields Many factors affect bond yields The difficulty is that there are many factors that affect bond yields — and government debt and the budget deficit is often an unimportant factor.
Only in certain circumstances will levels of government borrowing have a major impact on bond yields.
Impact of National Debt on Economic Growth | Economics Help
The most important factors for determining bond yields are probably inflation, interest rates and the rate of economic growth. Bond yields and Eurozone economies During andseveral Eurozone economies saw rising bond yields. This occurred during a period of rising budget deficits and higher government borrowing.
EU policy often stated at the time, borrowing needed to be reduced in order to reduce bond yields. However, the main problem for countries like Ireland and Italy and Spain was that there was no Central Bank willing to act as lender of last resort.
Therefore, markets saw a real possibility of liquidity shortages, and this caused investors to be nervous.
When the ECB decided to effectively act as lender of last resort after and intervene in bond markets, bond yields fell. This means that if John Smith spends less, this does not affect how much John Smiths employer pays him. If a company spends less, it may or may not affect its income depending on whether that spending was generating immediate income. However, if a government cuts its spending in an economy where unemployment is high, it is directly and immediately affecting the country GDP and in-turn its own revenues.
In the US right now, that velocity is 1. Why do I say "at least"? It is not even economics, it's just simple mathematics. Now of course if the economy was strong and employers were having difficulty finding people to take jobs, any reduction in spending by the government would be quickly offset by hiring in the private sector. However, somehow I don't think the argument from the deficit hawks is that the economy is growing too strongly and the unemployment is too low.
Companies are not exactly starved for job applicants and the job market is anything but tight. The most likely effect of the cuts to public spending is to simply add those people cut to the already large waiting line in the unemployment offices.
To be fair, a closer look at US employment figures over the past few years reveals that while government spending cuts have been devastating to overall employment figures, they have been offset by a surprisingly strong private sector. This is not to say the private sector is firing on all cylinders, but it is certainly doing far more good for the economy then the currently popular government policies of deficit fighting. This article here shows just how much a drag the government has been during this recovery as compared with other recoveries, though I disagree with the author that more spending is not necessary.
In fact, it's very likely that without the deficit cutting measures enacted in so many countries all at once, and if government spending in the US was maintained at the same level as in previous recoveries, we would have a solid recovery underway already.
From an investment perspective, it is very important to understand this difference since it shows that the great US economic engine is anything but dead.
Rising public debt-to-GDP can harm economic growth
The private sector is doing a great job thus far in the recovery, which is driving the profit and stock market price increases, but it needs the government to at minimum maintain if not outright grow. To the individual investor, this means ignoring all the doomsayers who believe we need years of debt purging before the economy can truly recover and that governments are helpless to speed this up.
Any policy shift from the government in favor of growth and away from deficit debt fighting will in fact be very successful in creating a strong recovery. Since the overall debt burden on the economy is falling regardless of what the government is doing, and the private economy is improving despite being actively hampered by government layoffs, there is no reason to believe that the stock market increases we have seen since the trough of the recession are unreasonable.
In fact, it might be a very good time to invest in broad market indices using ETFs such as SPYQQQDIA in the US, since whoever wins the election this year is likely to pursue spending or tax cutting policies without much offset, regardless of what they promise.