Suppose that for the nation of Calliope, the debt-to-GDP ratio is 325%, the average annual growth rate is 1.1%, the average inflation rate is 0.5%, and the average nominal interest rate is 2.2%
Based on this information, determine if fiscal policy is sustainable in Calliope, and if not, what the primary budget deficit would have to be to make fiscal policy sustainable.
The real interest rate = 2.2 - 0.5 = 1.7%. Since the real interest rate is greater than the growth rate, Calliope's fiscal policy is not sustainable.
The primary deficit needed to sustain the debt + (the real interest rate - the growth rate)(debt-to-GDP ratio = 0
0 = PDt/PtYt + (0.017 - 0.011 )(3.25 )
0 = PDt/PtYt + 0.0195
PDt/PtYt = -0.0195, or -1.95%
This means that Calliope would have to run a primary surplus of 1.95% of GDP to make fiscal policy sustainable.
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