This exercise allows you to use the government budget constraint to study how the debt-GDP ratio changes over time. Suppose a government has an initial debt of $5 trillion, and the nominal interest rate is 5%.
(a) If the government keeps its primary budget in balance, what is the growth rate of its debt? Why?
(b) If the government keeps its total budget in balance, what is the growth rate of its debt? Why?
(c) Suppose the country’s GDP grows at 4% per year. What happens to the debt-GDP ratio over time in the two cases of parts (a) and (b)?
(d) Are the situations in part (c) sustainable? Why or why not?
