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Debt-to-GDP ratio

Government debt measured against annual output; its direction depends on the gap between the interest rate on the debt and the nominal growth rate, plus the primary balance.

The dynamics come down to r minus g. When the average nominal interest rate paid on the debt is below nominal growth, the ratio falls even with a small primary deficit. When it is above, stabilising the ratio requires a primary surplus.

This is why nominal growth and the level of long yields matter more to fiscal sustainability than the deficit headline. A shift from a negative to a positive r minus g gap changes the arithmetic from self-correcting to self-reinforcing.

Example: debt is 120% of GDP, nominal growth is 4.2% and the average interest rate on the debt is 3.4%. The favourable gap of 0.8 points reduces the ratio by 1.20 x 0.8 = about 0.96 points a year before any primary deficit is added back.

Related: real-gdp, term-premium, quarterly-refunding, current-account, treasury-auction

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