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Measuring Inflation - Balanced Budget

Guatemala government has an outstanding debt of $18.23 billion and its GDP is 30% higher than the debt.  The nominal interest rate is 5%.  The inflation rate is 2%.  
a. What   is   the   sustainable   deficit   ratio   if   the   country   is   growing   at   5%?   How  about  when inflation goes to â?2%?  

b.What  about  if  the  country  grows  at  2%?  How  about  when  inflation  goes  to  â?7%?  

c. Is Guatemala's debt sustainable if the government runs a balanced budget in both a and b.

Solution Preview

For these problems we can use the government budget equation, bt = d + (1+i )/ (1+n) bt-1, where b is the ratio of debt to GDP, d is the ratio of deficit to GDP, i is the nominal interest rate and n is the growth rate of GDP. bt is the debt ratio for the current period, and bt-1 is for the prior period. At the steady state value of b, we find that bt = bt-1 (debt is not changing).

Solving for steady-state value of b an inserting ...

Solution Summary

Guatemala's debt and calculation of sustainable deficit levels.