What is the debt-to-GDP ratio?
The debt-to-GDP ratio is the measure that compares a country’s public debt to its gross domestic product (GDP). By comparing what a country owes to what it produces, the debt-to-GDP ratio reliably indicates that country’s ability to repay its debts. Often expressed as a percentage, this ratio can also be interpreted as the number of years necessary to repay the debt, if the GDP is entirely devoted to repaying the debt.
A country capable of continuing to pay interest on its debt – without refinancing and without hampering economic growth, is generally considered to be stable. A country with a high debt-to-GDP ratio generally finds it difficult to repay its external debts (also called “public debts”), which are balances owed to external lenders. In such scenarios, creditors are likely to look for higher interest rates when they lend. Extremely high debt-to-GDP ratios can deter creditors from lending money.
The debt-to-GDP ratio formula is
TheDebt to GDP=Total GDP of the countryTotal debt of the countryTheTheThe
What does the debt to GDP ratio tell you?
When a country defaults on its debt, it often triggers financial panic in national and international markets. In general, the higher the debt-to-GDP ratio of a country, the higher its risk of default. Although governments strive to reduce their debt-to-GDP ratios, this can be difficult to achieve during times of turmoil, such as war or economic recession. In these difficult climates, governments tend to increase borrowing in order to stimulate growth and stimulate aggregate demand. This macroeconomic strategy is an ideal ideal in Keynesian economics.
Economists who adhere to modern monetary theory (MMT) argue that sovereign nations capable of printing their own money can never go bankrupt, as they can simply produce more fiat money to pay off debts. However, this rule does not apply to countries that do not control their own monetary policies, such as European Union (EU) countries, which must rely on the European Central Bank (ECB) to issue euros.
A World Bank study found that countries with debt-to-GDP ratios above 77% for extended periods of time are experiencing significant declines in economic growth. Obviously: each percentage point of debt above this level costs countries 1.7% of economic growth. This phenomenon is even more pronounced in emerging markets, where each additional percentage point of debt greater than 64% annually slows growth by 2%.
Key points to remember
- The debt-to-GDP ratio is the ratio of a country’s public debt to its gross domestic product (GDP).
- If a country is unable to pay its debt, it defaults, which could cause financial panic in domestic and international markets. The higher the debt-to-GDP ratio, the less likely the country is to repay its debt and the higher its risk of default.
- A World Bank study found that if a country’s debt-to-GDP ratio exceeds 77% for an extended period, it slows economic growth.
Examples of debt to GDP ratios:
Debt-to-GDP Patterns in the United States
According to the United States Public Debt Office, in 2020 and 2020, the United States had debt-to-GDP ratios of 104.17% and 105.4%, respectively. To put these figures into perspective, the highest debt-to-GDP ratio in the United States was 121.7% at the end of the Second World War in 1946. The level of debt gradually declined from its peak after World War II, before reaching between 31% and 40% in the 1970s – finally reaching a historic low of 31.7% in 1974. Ratios have increased steadily since 1980, then have sharply increased after the subprime housing crisis in 2007 and the financial crisis that followed.
The role of US treasury bills
The US government finances its debt by issuing US treasury bills, which are widely regarded as the safest bonds in the market. The countries and regions with the 10 largest holdings of US Treasuries are:
- Taiwan at $ 182.3 billion
- Hong Kong to 200.3 billion dollars
- Luxembourg at 221.3 billion dollars
- The UK at $ 227.6 billion
- Switzerland at 230 billion dollars
- Ireland at $ 264.3 billion
- Brazil at 246.4 billion dollars
- The Cayman Islands at $ 265 billion
- Japan at 1.147 trillion dollars
- Mainland China at 1.244 trillion dollars
Debt to GDP limits
The 2020 historical study “Growth in Debt Times”, conducted by Harvard economists Carmen Reinhart and Kenneth Rogoff, painted a bleak picture for countries with high debt-to-GDP ratios. However, a 2020 review of the study identified coding errors, as well as the selective exclusion of data, which would have led Reinhart and Rogoff to draw erroneous conclusions. Although the corrections to these miscalculations have undermined the central claim that excess debt causes recessions, Reinhart and Rogoff still maintain that their conclusions are nevertheless valid.