Debt to GDP

Leading/Coincident/Lagging: Lagging Economic Indicator
Type: Measurement

Summary: The ratio of Debt to GDP is controlled by the government’s tax revenue versus its spending. The difference between Government Tax Revenue and Government Expenses must be paid for in some way, typically one of two ways. A government’s central bank can print money (which is inflationary), and the government’s budget policy can borrow money. Borrowing money raises Debt to GDP. The government sells bonds to borrow to cover the difference between tax revenue and spending, and these bonds increase Debt to GDP.

If spending exceeds tax revenue, there is a current deficit. This is an “injection” or inflationary. The government is spending more money on the economy than it is removing via taxation. Releasing more money into the economy hurts the value of each existing dollar, but it helps stimulate an economy. There is value being added to the economy while consumers with existing currency can continue to spend money elsewhere on products and services.

If tax revenue exceeds spending, there is a current surplus. This is a “withdrawal” or deflationary. The government is currently removing money from the economy and giving back less, or nothing, in exchange. Removing money from the economy increases the value of each existing dollar, but slows the economy since consumers cannot that spend money elsewhere on businesses and transactions.

More money must be paid out to service the interest owed to bondholders with higher Debt to GDP. Any payment to bondholders is inflationary since it releases more money into the world. Any amount of Debt to GDP at all is somewhat Inflationary. A rising Debt to GDP also creates the possibility of default. The possibility of default creates uncertainty that scares investors away from an economy. Negative Debt to GDP is the only figure that could create deflation, but negative debt doesn’t exist.

Impact on Local Currency: Rising debt to GDP requires steadily increasing interest payments. These payments either require the raising of tax revenues to pay down debts, slowing the economy, or printing more money to meet payments. The printing of currency has an inflationary effect, as more money is being added to the money supply reducing the value of each existing unit of money. Exporting of currency to foreign debt holders also has an inflationary effect on currency, since the currency will most likely be sold when it is converted to the foreign bondholder’s domestic currency which reduces each unit’s value.