Credit: china.org.cn

1. How does the evolution of the debt-to-GDP ratio Bt/Yt depend on g (the growth rate) and i (the interest rate)?

2. Consider the steady-state debt-to-GDP ratio bss = B Y = (G − T)/Y g − i

(a) Derive this relationship mathematically. What does this relationship describe?

 (b) Assume an economy with a debt-to-GDP ratio of 75%. If it is growing at 3.0% per year, and the government pays an interest rate of 1.5% per year on its debt, how high a primary deficit can the government run (as a percent of GDP) without increasing its debt-to-GDP ratio?

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