Sustainability of deficits depends on the relationship between the government's interest rate on debt and the growth rate.

• A. Only on the current deficit
• B. On inflation
• C. On the difference between interest rate and growth rate
• D. On tax revenue

Answer: (C)

The debt path over time is what determines whether deficits can be sustained. If the economy grows faster than the cost of servicing the debt, deficits can be financed more easily because the bigger economy makes the debt share of GDP grow more slowly, stabilize, or even fall. The key factor that drives this relationship is the difference between the interest rate on government debt and the growth rate of the economy. When growth exceeds the interest rate, the debt burden tends to be easier to manage; when the interest rate on debt exceeds growth, debt can keep rising as a share of the economy unless a larger primary surplus is used. Inflation, current deficit size, or tax revenue play roles in budgeting, but the fundamental sustainability question hinges on the gap between i and g.