The Debt to GDP ratio compares the country’s debt (total debt owed by the National/Federal/Central Government) to its total economic output for the year, as measured by GDP, Gross Domestic Product. The debt to GDP ratio gives investors a rough gauge as to a country’s ability to pay off its debt.
The Ratio of Debt to GDP Increases:
- During War
- In a recession
The Ratio of Debt to GDP Decreases:
- as a result of government surplus
- stimulus spending
Is there a tipping point as to where public debt negatively affects the economic growth?
According to a 2010 study by, Caner, Mehmet; Grennes,Thomas; Koehler-Geib, Fritzi; Koehler-Geib, Friederike, that tipping point is 77 percent public debt-to-GDP ratio. If debt is above this threshold, each additional percentage point of debt costs 0.017 percent points of annual real growth; a situations that causes investors to worry and consequently demand more interest rate return for the higher risk of default. This increases the country’s cost of debt and can quickly become a debt crisis. If a country were a household, GDP is like its income. Banks will give you a bigger loan if you make more money. In the same way, investors will be happy to take on a country’s debt if it produces more.
How to Use the Debt to GDP Ratio
The debt to GDP ratio allows investors in government bonds to compare debt levels between countries. For example,
Germany’s debt is $2.4 trillion; GDP is $2.9 trillion; so debt to GDP ratio is 83%
Greece’ debt is $434 billion; GDP is $318 billion; so debt to GDP ratio is 142% – high ratio indicates recession