What Is the Debt-to-GDP Ratio?
The debt-to-GDP ratio is a crucial metric that compares a country’s public debt to its Gross Domestic Product (GDP). By juxtaposing what a country owes with its economic output, this ratio provides a reliable measure of that country’s ability to repay its debts. Often expressed as a percentage, the debt-to-GDP ratio can also denote the number of years required to pay off the debt if the entire GDP is dedicated to debt repayment.
Key Insights
- Understanding the Metric: The debt-to-GDP ratio represents the fraction of a country’s public debt to its GDP.
- Implications of High Ratio: Higher ratios imply greater difficulty in repaying debts and increased risk of default, which could trigger financial turmoil domestically and internationally.
- Economic Stability: A lower debt-to-GDP ratio suggests a country is more stable and capable of paying its debts without hampering economic growth.
Calculating the Debt-to-GDP Ratio
The debt-to-GDP ratio is calculated using the formula:
Debt to GDP = (Total Debt of Country) / (Total GDP of Country)
A country is seen as financially stable if it continues servicing its debt interest without refinancing and without impeding economic growth. However, high debt-to-GDP ratios often signal difficulty in repaying external debts, leading creditors to demand higher interest rates and, at extreme levels, refraining from lending altogether.
The Significance of the Debt-to-GDP Ratio
A country defaulting on its debt generally results in financial panic in both domestic and global markets. The higher a country’s debt-to-GDP ratio, the greater the likelihood of default. While reducing this ratio is a government priority, it becomes challenging during periods of unrest, like wars or economic recessions, often requiring increased borrowing to stimulate growth and aggregate demand.
Contrasting Perspectives on Debt
Modern monetarists argue that nations that can print their own currency cannot go bankrupt because they can produce additional fiat money to cover debts. This viewpoint diverges significantly for countries that don’t control their monetary policies (e.g., EU nations relying on the European Central Bank).
Evaluating Debt-to-GDP Ratios: Good vs. Bad
Research suggests countries with debt-to-GDP ratios above 77% for extended periods experience a notable slowdown in economic growth. Specifically, each percentage point of debt over this threshold reduces economic growth by 0.017%, with more pronounced effects in emerging markets, where growth slows by 0.02% for every percent over a 64% debt-to-GDP ratio.
Current U.S. Debt-to-GDP Ratio
As of Q3 2023, the U.S. debt-to-GDP ratio stands at 120.13%, almost double the levels seen in early 2008 but down from the pandemic’s peak of 132.96% in Q2 2020. The ratio has been above 77% since Q1 2009. Historical context reveals a previous high of 106% post-World War II in 1946, with subsequent reductions until a gradual increase post-1980, culminating in significant spikes after the subprime mortgage crisis and the COVID-19 pandemic.
Considerations
The U.S. funds its debt by issuing U.S. Treasuries, often considered the safest bonds available. As of December 2023, the top global holders of U.S. Treasuries include Japan, China, and the United Kingdom, among others.
Risks of a High Debt-to-GDP Ratio
Elevated debt-to-GDP ratios suggest increased default risks, which can lead to global financial disruptions.
Modern Monetary Theory on National Debt
Modern monetary theory posits that countries capable of printing their currency need not worry about taxes or borrowing constraints for spending, as they can generate the necessary funds, diverging from traditional fiscal policies shaped by national debt concerns.
Global Debt-to-GDP Ratios
As of 2022, Japan held the highest debt-to-GDP ratio globally at 261.3%, followed by Greece at 177.4%, with the U.S. placed fifth at 121.4%.
Conclusion
The debt-to-GDP ratio is a vital metric that helps gauge a country’s debt repayment capacity and overall financial health. A lower debt-to-GDP ratio is favorable, indicating a country’s production outweighs its debts, thereby projecting greater economic stability and strength.
Related Terms: Gross Domestic Product (GDP), Public Debt, External Debts, Modern Monetary Theory (MMT).
References
- Congressional Budget Office. “Federal Debt: A Primer”.
- European Union. “European Central Bank”.
- The World Bank. “Finding the Tipping Point – When Sovereign Debt Turns Bad”.
- Federal Reserve Bank of St. Louis, FRED Economic Data. “Federal Debt: Total Public Debt as Percent of Gross Domestic Product”.
- Treasury Direct. “About Treasury Marketable Securities”.
- U.S. Department of the Treasury. “Major Foreign Holders of Treasury Securities”.
- International Monetary Fund. “General Government Debt: Percent of GDP”, Sort by Value.
