Assume that a country’s real growth is 2 percent per year, while its real deficit is rising 5 percent a year.
a. Can the country continue to afford such deficits indefinitely?
a. No. The country needs to run surpluses so that it can contribute to the productive capacity of the economy.
b. Yes. The country can continue to afford such deficits as long as it can sell bonds.
c. Yes. The country can continue to afford such deficits. Whether the country’s budget is in deficit or surplus is a concern for accountants, not economists.
d. No. The country cannot afford any deficit, no matter its size. A budget deficit is an unnecessary burden to a country’s economy.
b. What problems might it face in the future?
a. Government will have to offer lower and lower interest rates in order to attract investors, crowding out private investment.
b. The excessive government spending will necessarily lead to hyperinflation, which will reduce growth.
c. The government will not face problems in the future since deficits are an accounting problem, not an economic problem.
d. At some point, creditors will begin to doubt the country's ability to repay the debt because of the increasing debt-to-GDP ratio. Then selling bonds will become more difficult and eventually impossible.