Problem
In this problem you are asked to analyze the question: By issuing new bonds and using the proceeds to pay the interest on its old bonds, can government avoid ever repaying its debts?
a. Suppose that nominal GDP is $1 billion and the government has $100 million of bonds outstanding. The bonds are one-year bonds that pay a 7% nominal interest rate. The growth rate of nominal GDP is 5% per year. Beginning now the government runs a zero primary deficit forever and pays interest on its existing debt by issuing new bonds. What is the current debt-GDP ratio? What will this ratio be after 1, 2, 5, and 10 years? Suppose that, if the debt-GDP ratio exceeds 10, the public refuses to buy additional government bonds. Will the debt-GDP ratio ever reach that level? Will the government someday have to run a primary surplus to repay its debts, or can it avoid repayment forever? Why?
b. Repeat Part (a) for nominal GDP growth of 8% per year and a nominal interest rate on government bonds of 7% per year.
The response should include a reference list. Double-space, using Times New Roman 12 pnt font, one-inch margins, and APA style of writing and citations.