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One factor in determining the economic position of a country is through a comparison of public debt to the gross domestic product (GDP) of the country. This comparison is often listed as a percentage of how much of the GDP it would take to pay off the public debt. A low public debt and GDP percentage is usually an indication of economic health, while a high public debt and GDP percentage can indicate financial trouble for a country.
The GDP of a country measures its total output of all goods and services. Generally measured on a yearly basis, the GDP can actually be calculated in several different ways. Most common means of calculating the GDP involve totaling the created wealth of country-produced goods and services and subtracting expenditures and imports. Almost all accepted formulas for calculation will return roughly similar results.
Public debt refers to all money owed by branches of government within a nation. This includes external debt to foreign investors as well as debt owed to citizens through systems such as bonds. Public debt can be incurred by any branch or level of government, including local governments, state or regional governments, and federal branches.
It is important to note that the relationship between public debt and GDP is abstract. Nations do not actually pay off public debt per year according to the ratio of debt and GDP. Since most public debt is paid off over many years and even altered or added to as time goes by, the relationship between public debt and GDP is merely used to illustrate and illuminate the financial state of a nation.
Despite the limited real meaning of GDP and public debt ratios, the comparison is taken very seriously, as it indicates how able a nation will be to pay off debts. When the Eurozone was created in 1999, member nations had to prove a debt to GDP ratio of under 60% to be allowed to join the currency. This was to ensure that the euro would remain relatively stable despite becoming the backbone of many widely different economies throughout Europe.
GDP and public debt are constantly linked in discussion about economic health. A country with a higher debt than GDP may be in serious financial trouble, just like a person who has more credit card debt than yearly income. While the individual foundering in debt may have trouble fending off creditors and facing falling credit scores, a nation in financial trouble can cause problems that may damage economies throughout the world.
If a nation defaults on public debt, billions or even trillions of dollars may be at stake. Governments may not be able to make good on internal debt such as bonds, while foreign investors may go unpaid for goods, services, or loans purchased on the credit of the drowning country. For this reason, intergovernmental watchdog agencies such as the International Monetary Fund have been established to help recognize growing potential for default and help prevent this from occurring. Though somewhat shadowy and controversial, these agencies attempt to help countries lower public debt and GDP ratios to help promote a healthy economy capable of making good on all debts.