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Chapter 13: Q10. (page 283)

Why might economists be quite concerned if the annual interest payments on the US public debt sharply increase as a percentage of GDP?

Short Answer

Expert verified

A high-interest payment reduces the capacity of an economy to repay the debt. Therefore, economists stay more concerned about a rapid increase in annual interest payments on US public debt.

Step by step solution

01

Burden of interest payment on public debt

A government borrows funds in exchange for some notes or bonds, or other government securities.The cost of the public debt is the interest accumulating over the securities.A government has to return the principal amount and the interest payment on that amount to become debt-free.

Therefore, the interest payment adds to the burden of the public debt.

02

Explanation for the answer

Public debt as a percentage of GDP represents the payment capacity of the economy depending on its GDP size.If interest payment increases sharply, it becomes an alarming situation for the economy. Higher interest will weaken an economy and reduce the possibility of repaying the debt because of an overvalued burden.

Therefore, the economists are more worried about significant hikes in the annual interest payment on the public debt as a percentage of GDP.

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Most popular questions from this chapter

How do economists distinguish between the absolute and relative sizes of the public debt? Why is the distinction important? Distinguish between refinancing the debt and retiring the debt. How does an internally held public debt differ from an externally held public debt? Contrast the effects of retiring an internally held debt and retiring an externally held debt.

Define the cyclically adjusted budget, explain its significance, and state why it may differ from the actual budget. Suppose the full-employment, noninflationary level of real output is GDP3 (not GDP2) in the economy depicted in Figure 13.3. If the economy is operating at GDP2 instead of GDP3, what is the status of its cyclically adjusted budget? The status of its current fiscal policy? What change in fiscal policy would you recommend? How would you accomplish that in terms of the G and T lines in the figure?

Briefly state and evaluate the problem of time lags in enacting and applying fiscal policy. Explain the idea of a political business cycle. How might expectations of a near-term policy reversal weaken fiscal policy based on changes in tax rates? What is the crowding-out effect, and why might it be relevant to fiscal policy?

(For students who were assigned Chapter 11) Assume that, without taxes, the consumption schedule for an economy is as shown below:

GDP, Billions

Consumption, Billions
\(100120
200200
300280
400360
500440
600520
700600

  1. Graph this consumption schedule. What is the size of the MPC?

  2. Assume that a lump-sum (regressive) tax of \)10 billion is imposed at all levels of GDP. Calculate the tax rate at each level of GDP. Graph the resulting consumption schedule and compare the MPC and the multiplier with those of the pretax consumption schedule.

  3. Now suppose a proportional tax with a 10 percent tax rate is imposed instead of the regressive tax. Calculate and graph the new consumption schedule, and calculate the MPC and the multiplier.

  4. Finally, impose a progressive tax such that the tax rate is 0 percent when GDP is \(100, 5 percent at \)200, 10 percent at \(300, 15 percent at \)400, and so forth. Determine and graph the new consumption schedule, noting the effect of this tax system on the MPC and the multiplier.

  5. Use a graph similar to Figure 13.3 to show why proportional and progressive taxes contribute to greater economic stability, while a regressive tax does not.

Assume that a hypothetical economy with an MPC of .8 is experiencing a severe recession. By how much would government spending have to rise to shift the aggregate demand curve rightward by $25 billion? How large a tax cut would be needed to achieve the same increase in aggregate demand? Determine one possible combination of government spending increases and tax decreases that would accomplish the same goal.
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