Public Debt

1. If government debt grows to finance new military spending, this may impose a burden on future
generations only to the extent that:
A. war is bad.
B. government spending crowds out investment spending.
C. government spending on the military is investment expenditure.
D. the government debt needed to finance the military expenditures is held internally.
2. Crowding out is most severe when the:
A. budget deficit is large because of a recession.
B. economy is close to full employment.
C. economy is experiencing stagflation.
D. the Aggregate Supply Curve is relatively flat.
E. the Aggregate Demand Curve is relatively flat.
3. NOT among legitimate concerns about the burden of the growing public debt would be that:
A. investment is reduced.
B. interest rates are excessively high.
C. the government will go bankrupt.
D. government spending grows at excessive rates.
4. The least expansionary method of financing new government spending is to:
A. borrow money within the country.
B. borrow money abroad.
C. increase taxes.
D. increase the money supply.
5. What does public debt refer to
A. The total revenue collected by the government
B. The loans incurred by the government to finance its activities
C. The taxes imposed on citizens
D. The interest paid by the government on external borrowing
6. What is the primary objective of raising public debt to meet budget deficits
A. To increase taxation.
B. To fund development projects
C. To reduce government expenditure
D. To avoid changes in the tax system
7. Which type of public debt is incurred to defray the expenses of war and extraordinary situations?
A. Public debt for development purposes
B. Public debt to meet budget deficits
C. Public debt for emergencies like war
D. Productive public debt
8. What is the main burden of external debt on a country?
A. Reduces domestic consumption
B. Increases taxation
C. Boosts domestic investment
D. Improves trade balance
9. What does the debt-service ratio measure
A. The total external debt of a country
B. The interest rate on public debt
C. The repayment of principal on public debt
D. The obligations of a country for a year on its external debt as a percentage of its exports

10. What is the primary effect of large public debt on an economy’s growth?
A. Accelerates economic growth
B. Slows down economic growth
C. Has no impact on economic growth
D. Leads to hyperinflation

11. Which problem arises due to public debt diverting capital from the private sector to the public
sector?
A. Inflation
B. Economic growth
C. Fiscal deficit
D. Crowding out

12. What is the primary purpose of a sinking fund in public debt management?
A. To create an emergency fund for the government
B. To raise funds for new development projects
C. To accumulate resources for repaying the debt at maturity
D. To finance war expenses

13. Which method of debt repayment involves the government paying off the debt in equal annual
installments?
A. Refunding
B. Conversion
C. Sinking Fund
D. Terminal Annuity

Essay Question
Define public debt redemption and discuss its methods.

Redemption of Public Debt is defined as a process of repayment of public debt.

Methods of Redemption of Public Debt
1. Conversion of Public Debt:
Conversion is defined as the process of converting existing debt into a new debt. This method reduces
the interest burden by converting old loans that bear high interest into new loans that bear low
interest. The method of conversion is implemented generally when the rate of interest in the market
goes down. The lenders of money are given the instructions to take back their money in the form of
cash or the form of new bonds. This method helps taxpayers by reducing their burden of interest. The
conversion results in less unequal distribution of income because of the assumption that the
taxpayers are mostly poor people whereas the lenders are the rich people.
2. Refunding:
Refunding of debt is defined as a process where governments issue new securities and bonds for
repayment of old loans(matured loans). In the process of refunding, the short-term securities are
replaced by long-term securities. When the refunding method is adopted by the government there is
no burden of public debts.
3. Creation of Sinking Fund:
The creation of a sinking fund is defined as a process where the funds are created by the government
and are accumulated each year by keeping them separately so that they are sufficient for paying off
debts during the maturity period. Every year a specific amount of money is transferred to this fund so
that it will be enough to redeem public debt. The creation of a sinking fund is considered the best and
most systematic method of redemption of public debt. While using this method the overall burden of
repaying the debts is felt less as it is evenly distributed throughout the year.
4. Capital Levy:
Capital Levy is considered the most controversial method of redemption of public debt. Capital levy is
defined as a method where governments impose a levy on the assets of the rich people or sections of
the society. During war or emergencies, governments usually raise money by imposing a special tax on
the capital to redeem public debts. Quick repayment of loans is possible with capital levy. However,
using this method has various disadvantages such as it hampers capital formation, employment and
production are also adversely affected, etc. This method is mostly not adopted by the governments.
5. Terminal Annuity:
Terminal Annuity is defined as a method where the government pays off its public debt through equal
annual installments that consist of principal and interest. The terminal annuity method is similar to
the method of sinking funds. Therefore, many times governments decide to end or terminate the
public debt using the terminal annuity method. The amount of the terminal annuity is decided based
on the annuity table. Through this method, the burden of public debt is reduced every year and paid
fully until the maturity period.
6. Additional Taxation:
Additional taxation is defined as a type of method where the government imposes new taxes on
people to get the required revenue for repayment of the public debt. This revenue is used to repay
the principal amount as well as the interest amount. To pay the old debt the government levies both
taxes such as direct and indirect. This method of additional taxation causes income redistribution as
the resources are transferred from taxpayers to the bondholders. Using this method of additional
taxation has a distortionary effect on the taxes.
7. Budget Surplus:
Budget Surplus is a condition where government incomes are more than government expenses. In
case of a budget surplus, the excess earnings can be utilised by the government to pay back the
principal amount borrowed under public debt. The government generally uses the budget surplus to
buy its bonds and securities from the market.
8. Balance of Payments Surplus:
Public debts can be redeemed using the surplus balance of payments. For this, the country must
increase its exports and/or decrease its imports. This will lead to the accumulation of foreign reserves
within the country, which the respective country can use to pay off its public debts.
9. Compulsory Reduction in the Rate of Interests:
The government may pass the notice to decrease the interest rates payable on public debts. This
generally happens in case of a government budget deficit or any other financial difficulties. In such a
situation, the creditors have no other option except to reduce the interest rates.
10. Repudiation:
It is a term used when the government refuses to pay back off its public debts. A government can
repudiate its international loans. However, the repudiation done by the governments affects their
credit score in the money market and makes it difficult to access loans in the future.