Question

Discuss how each of the following can help to reduce the debt burden on governments. What are the problems and potential negative consequences associated with each method?

a) reducing the primary deficit,
b) increasing the growth rate,
c) reducing the interest rate,
d) reducing the existing stock of debt.

Answer 1

a) Reduction in primary deficit- Primary deficit is the difference between Fiscal deficit for current year- Interest payments on previous debt/borrowings. So a reduced primary deficit overall decreases the debt burden of the government.

Problem and potential consequences- Reduction in primary deficit or low or zero primary deficit exhibits that it has forced government to borrow money to pay off for the interest payments on accumulated debt/borrowings.

b) Increasing in the growth rate means increase in GDP, increase in per capita income and decrease in the burden on the government to spend on social welfare schemes, reduction in the fiscal deficit budget for increasing the public spending and boosting the economy and this resultantly reduces the debt burden on the governments because they won't have to borrow money and won't have to make interest payment on the borrowings and don't have to follow the fiscal deficit measures in order to increase public spending and decrease taxes in order to boost the economy.

Problem and potential consequences- Increase in growth rate will increase inflation since due to growth in GDP of the economy its people's per capita income will get increased and people will have more money to spend and one more negative consequence will be that due to increase in GDP and increase in aggregate demand for goods and services, interest rates will get increased since aggregate demand will be more than aggregate supply and due to that inflation and rate of interest will get increased.

c) Reduction in interest rates will increase the borrowing by firms and individuals and this will resultantly increase the investment in the production of goods and services and for to increase in production of goods and services, demand for labor will get increased and due to that labor will get more money income and they will spend money for purchasing the goods and services and exports will also get increased and this will increase the GDP of the economy and due to that government will have to borrow less from domestic and international markets and due to increased exports government will earn foreign exchange and its foreign exchange reserves will get increased and due to low/reduced interest rates domestic people will substitutes imports with locally produced goods and services and this will reduce the debt burden of the government since they will have to pay less in terms of import payments and less in terms interest payments on borrowings from domestic as well as international market.

Problem and potential consequences- Reduction in interest rates will increase production, increase in income of labor and increase in aggregate demand for goods and services which will increase the inflation since due to demand and supply factors, demand will be more than supply and this will also increase the wage rates of labor.

d) Reduction in the existing stock of debt- By reducing the existing stock of debt means government is able to pay its debt and its debt to GDP ratio is decreasing and it is measured as a difference between nominal GDP and interest rates and a higher difference between them signifies that government is able to pay off its debt and a low primary deficit and primary surplus also brings down the debt to GDP ratio.

Problem and potential consequences- Reduction in existing stock of debt stock means government has less fiscal deficit and this also reduces the governments capacity to spend on public projects/infrastructure and less public expenditure on social welfare programs which affect the public at large and also if the economy is in recession that reduced public expenditure won't be able to help the economy to come out of recession and also it will not be able to increase the employment level and decrease the unemployment.