4 Debt-to-GDP ratio

The absolute value of public debt for a specific country is often put into context by stating it relative to the general level of economic activity in that country, measured as GDP.4 When public debt is reported in this way, we call it the debt-to-GDP ratio.

Similary, to measure the relative increase in a government’s indebtedness over time, we can look at the deficit expressed in percent of GDP, the deficit-to-GDP ratio.

Debt-to-GDP ratio and deficit-to-GDP ratio: These measures state public indebtedness and its change relative to the overall economic activity in an economy, commonly measured by GDP.

\[\text{Debt-to-GDP ratio} = \frac{\text{Total public debt}}{\text{GDP}}\] \[\text{Deficit-to-GDP ratio} = \frac{\text{Public deficit}}{\text{GDP}}\] To express these in % of GDP, simply multiply each ratio by 100.

Both, the debt ratio and the deficit ratio are often reported in media coverage about the government’s finances and in economic policy debates.

In the app below, you can explore the development of the absolute amount of debt, of GDP and of the debt and deficit ratios for specific countries and check if your expectations (if you had any) are met by the data.

Explore the data: In this app, you can explore the development of nominal GDP, the stock of public debt, the debt ratio and the deficit ratio for various countries .

Go to app

The government might be concerned about the level of indebtedness relative to the size of it’s economy. If the debt-to-GDP ratio is perceived as being too high, the government might want to try to bring it down. But a policy of strong expenditure cuts or raising taxes with the aim of lowering public debt ratio does not automatically lead to a decline of the debt-to-GDP ratio. Instead, so called austerity policies can just as well lead to a supression of aggregate demand, which can bring down GDP. As a result, the debt-to-GDP ratio might actully stagnate or rise. This is escpecially problematic, if austerity policies are conducted during periods of recession, as happend in the aftermath of the 2008 global financial crisis, especially in euro area countries. The app from above illustrates this with the examples of Spain and Greece.

In the next sections, we will illustrate in a simple way, what are the basic determinants of the debt-to-GDP ratio and how fiscal consolidation could be achieved and what some challenges are.

Is the debt-to-GDP ratio good indicator of the public debt-burden? The conventionall use of the debt-to-GDP ratio as a measure of the public debt burden has been exposed to critizism. For example, here is what Jason Furman, a leading economic expert in the US and outspoken critique of the debt-to-GDP ratio as an indicator of the debt burden, says in an interview with Dezernat Zukunft, the German Institute for Macrofinance, about the debt-to-GDP ratio:

The debt-to-GDP ratio is a misleading indicator because it takes a stock (debt, which is measured at a point in time) and compares it to a flow (GDP, which is measured over a period of time). If you look at the U.S. debt-to-GDP ratio for December 2020 it was over 1,000 percent while the debt-to-GDP ratio for the 2010s was about 10 percent. Which unit of time should we use for the denominator, a month, a year, a decade?

In reality, no country will pay off its debt in a single year, it will always be paid off over time. That is why the stock-flow point is not just a cute observation but very important in understanding how debt-to-GDP ratios mean different things at different points in time. When interest rates are lower it is easier to rollover debt and pay it off over time.

The biggest problem with debt-to-GDP ratios is that people treat them as an invariant yardstick, like temperature where 25 degrees Celsius was hot thirty years ago and is hot today. But in reality, debt-to-GDP is a changing yardstick and 60 percent debt-to-GDP in 1992 had a very different meaning than it has today.

– Jason Furman5

Instead of the debt ratio, one could, for example, also use the ratio of interest payments to GDP or to government revenues as other indicators of a country’s public debt burden. However, the debt-to-GDP ratio remains the most commonly used indicator. Therefore, we also focus on this indicator in this course.