1. Suppose that the national debt is 100 percent of GDP at the end of FY2022 (so the debt ratio is 1.00 in decimal terms). Suppose that in FY2023, the government runs a deficit equal to 7 percent of GDP (so the deficit ratio is 0.7 in decimal terms).

(a) Suppose that real GDP growth in FY2023 is 4 percent (0.04 in decimal terms), while the inflation rate is 0 percent. What is the growth rate of nominal GDP? What is the debt ratio at the end of FY2023?

(b) Re-do part (a), assuming the inflation rate is 10 percent (0.10 in decimal terms), holding everything else the same. Why is the debt ratio at the end of FY2023 smaller in part (b) than it was in part (a)?

Hint for parts (a) and (b): remember from class the following heuristic rule, where g is the nominal GDP growth rate in Year T and where all variables are in decimal terms:

Debt Ratio (end of year t) =

Debt Ratio (end of year T-1) + Deficit Ratio (year T) - g

(c) Explain in words what happened to the actual debt ratio in the United States between 1946 and 1976, using the formula above as a reference. Did the debt ratio rise or fall over time? Why did it rise or fallwas the change in the debt ratio driven by budget deficits or surpluses, or by changes in nominal GDP growth? How did inflation help the US escape its high debt ratio at the end of World War II?