The public debt ratio will always fall when economic growth is positive because the primary deficit falls due to the automatic stabilisers (more tax revenue, less welfare spending) and the denominator GDP rises.
Answer: False
The answer is False.
There are two false statements in the proposition.
First, the use of the word always makes the proposition false per se.
Second, the primary deficit may not fall when economic growth is positive if discretionary policy changes offset the declining net spending as tax revenue increases and welfare payments fall (the automatic stabilisation).
The framework for assessing this claim is given by the following relationship:
This can be expressed in words in the following way.
1. The lowercase t indicate time t (now), whereas t-1 is the last period before now.
2. The left hand term (left of the equals sign) indicates the change (Δ) the change in the debt ratio (B/Y).
3. The change in the debt ratio is thus the sum of two terms on the right-hand side of the equals sign:
(a) the difference between the real interest rate (r) and the GDP growth rate (g) times the debt ratio at the end of the last period; and
(b) the ratio of the primary fiscal deficit (G-T) to GDP, which is the difference between government spending (minus interest payments) and tax revenue.
A growing economy can absorb more debt and keep the debt ratio constant. For example, if the primary deficit is zero, debt increases at a rate r but the debt ratio increases at r - g.
Consider the following table which simulates two different scenarios.
Case A shows a real interest rate of zero and a steadily increasing annual GDP growth rate across 10 years. The initial public debt ratio is 100 per cent.
The fiscal deficit is also simulated to be 5 per cent of GDP then reduces as the GDP growth induce the automatic stabilisers. It then reaches a steady 2 per cent per annum which might be sufficient to support the saving intentions of the non-government sector while still promoting steady economic growth.
You can see that the even with a continuous deficit, the public debt ratio declines steadily and would continue to do so as the growth continued. The central bank could of-course cut the nominal interest rate to speed the contraction in the debt ratio although I would not undertake that policy change for that reason.
In Case B we assume that the government stops issuing debt with everything else the same. The public debt ratio drops very quickly under this scenario.
However, should the real interest rate exceed the economic growth rate, then unless the primary fiscal balance offsets the rising interest payments as percent of GDP, then the public debt ratio will rise.
The only concern I would have in this situation does not relate to the rising ratio. Focusing on the cause should be the policy concern. If the real economy is faltering because interest rates are too high or more likely because the primary fiscal deficit is too low then the rising public debt ratio is just telling us that the central bank should drop interest rates or the treasury should increase the discretionary component of the fiscal position.
In general though, the public debt ratio is a relatively uninteresting macroeconomic figure and should be disregarded. If the government is intent on promoting growth, then the primary deficit ratio and the public debt ratio will take care of themselves.
You may be interested in reading these blog posts which have further information on this topic: