Question

In which of the following cases does the size of the government's debt and the size of the budget deficit indicate potential problems for the economy? a. The government's debt is relatively low, but the government is running a large budget deficit as it builds a high-speed rail system to connect the major cities of the nation. b. The government's debt is relatively high due to a recently ended deficit- financed war, but the government is now running only a small budget deficit. c. The government's debt is relatively low, but the government is running a budget deficit to finance the interest payments on the debt.

Short answer

Answer: Case C is the most concerning for the economy because the government has to run a budget deficit to finance interest payments on its debt, despite having low debt levels. This indicates potential problems in the economy or inefficient use of government funds that require further investigation.

Step-by-step solution

Case A: Low Debt and Large Budget Deficit for Infrastructure Project

In this scenario, the government's debt is relatively low, meaning that the country has a stable economic situation. However, the government is currently running a large budget deficit to finance a high-speed rail system project. While large budget deficits may cause problems in the long-term, in this case, it could lead to improvements in the country's infrastructure, enhance transportation, and potentially boost the economy.

Case B: High Debt Due to a War and Small Budget Deficit

In this case, the government's debt is relatively high due to a recently ended war that was financed through deficits. Now, the government is only running a small budget deficit. It is important to consider why the deficit is small and if the government is taking steps to address its high debt level. While high debt might be concerning, it is not uncommon for countries facing extraordinary circumstances such as a war. If the government is taking steps towards stabilizing its debt, the situation might not be problematic for the economy.

Case C: Low Debt and Budget Deficit for Interest Payments

In this scenario, the government's debt is relatively low, which is generally positive for the economy. However, the government is running a budget deficit to finance the interest payments on its debt. This indicates that the government is not generating enough revenue to cover its debt payments without running a deficit, which could be a sign of an underlying problem in the economy or an inefficient use of government funds. Based on these analyses, the most concerning case among the three for the economy is

Case C

. In this case, the government's debt level is low, but the lack of revenue to cover interest payments and the need to run a deficit for this purpose indicate potential problems for the economy that require further investigation.