Monday, July 18, 2011

Economic Growth helps shrink the debt as a portion of GDP

Assume that a national debt is 50 percent of the GDP. Assume further that the GDP is growing at three percent per year, and the debt continues to grow at one percent per year. At the end of ten years, the debt is 41percent of GDP. Thus even if there is no progress in reducing the debt and it is allowed to grow, if it grows slower than the GDP, the debt over time becomes a smaller with respect to the GDP (and thus easier for the government to handle).

Assume that there is actually a one percent per year reduction of the debt while the GDP grows at three percent per year. In that case, at the end of a decade the debt has been reduced to 34 percent of the GDP. Thus even a modest reduction of the debt combined with a strong growth of GDP greatly reduces the ratio.

The lesson from this little example is that the debate over means of bringing the debt down to manageable size must include means to grow the economy!

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