How does government borrowing affect an economy?

National debt

A state's debt can be viewed from two perspectives:

  • The new government debt results from the difference between current government spending and government revenue. The annual deficit is usually set in relation to the economic output (gross domestic product) of the country.
  • Total government debt is a stock figure that builds up over the years. A country's mountain of debt has been measured since it was founded. This variable is also usually set in relation to economic output.

Effects of Public Debt

Public debt can have positive effects if the loans are used to finance public investments - for example in infrastructure. Such expenditures increase the growth potential of an economy in the medium term. Ideally, this means that the state can then reduce its deficit again through increasing tax revenues.

Even in exceptional economic situations, borrowing can make sense to compensate for a drop in demand on the part of companies and consumers.

The negative effects of national debt: On the one hand, increasing interest and repayment obligations are restricting the state's financial and budgetary leeway. On the other hand, increasing government borrowing harbors the risk of displacing private loans and investments from the market - with correspondingly negative consequences for economic growth.

Rules against growing national debt

The European Union tries to limit the national debt with the Stability and Growth Pact. The pact calls on the member countries to do so

  • new debt not exceeding 3 percent of gross domestic product,
  • a total debt not exceeding 60 percent of the gross domestic product.

In 2009, Germany also enshrined the so-called debt brake in the Basic Law.

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