A country can tolerate growing debt if its net long-term bond interest rate is kept below its GDP Growth Rate, what former World Bank Chief Economist Carmen Reinhart calls “financial repression”. Otherwise, a country will end up paying bond holders at a rate higher than GDP with negative consequences to the country’s balance sheet.

Government Spending refers to public expenditure on goods and services and is a major component of the GDP. Government spending policies on budgets, taxation and increasing public expenditure on public works are effective tools in influencing economic growth. Countries vary widely in how much they tolerate deficit spending, and nearly every country’s public debt has increased since 2000. A low ratio of Debt / GDP indicates the economy produces enough goods and services to repay the debt without incurring further debt. The Euro Convergence Criteria requires Euro Countries to keep Public Debt below 60% of GDP. According to Reinhart and Rogoff (Growth in a time of Debt, 2010, pg. 11, NBER Work Paper 15639), when the gross debt of the public sector exceeds 90% of GDP, median real GDP growth is 1% lower in the coming decade and the average growth rate is lower still. There is little evidence that countries can grow their economy enough to lower the debt to a manageable percentage of GDP. Instead, countries typically must adopt austere fiscal policies (increase taxes, decrease expenditures), restructure and roll over their debt, increase inflation so that debt is repaid with inflated currency, or hold interest rates low to reduce interest cost. A country that can “monetize” the debt by printing more money to pay for it but this will cause inflation. In emerging economies, an external Debt/ GDP ratio above 30-35% signals heightened risk of a credit crisis; Reinhart, C., Rogoff K., This Time is Different, 2009, p. 25.

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