The impact of debt on an economy continues to part of any thoughtful design of national policy.

George Vredeveld, Director of the Economics Center and the Alpaugh Professor of Economics (Emeritus) at the University of Cincinnati’s College of Business and Research Fellow at Varna Free University.

The impact of debt on an economy continues to part of any thoughtful design of national policy.  The basic fundamentals are straightforward.  Every time the government spends more than it receives in revenues it must borrow money to finance the resulting deficit.  This borrowing, which usually occurs through the sale of government bonds, adds to that country’s outstanding debt.  At the end of 2014, Bulgaria’s federal deficit was equal to about 28 percent of the total value of all goods and services sold (GDP) during the year.  This ratio is low compared to other European countries where the ratio ranges from a high of 177 percent of GDP in Greece to a low of 10.6 percent in Estonia.  Germany with a ratio of 75 percent sits in the middle of the pack.  Italy is near the top at 132 percent.

Some experts argue that when the government borrows, it competes with the private sector for funds available for lending.  The increase in the government demand for these loanable funds will increase the interest rate, making borrowing more expensive, and will “crowd out” private investments.  A reduction in private investments, which are essential to the health of the economy and productivity gains, leads to fewer good jobs, a less competitive economy and a decrease in our standard of living.

The central bank can try to offset the effects of this crowding out by increasing the money supply and the supply of loanable funds through the purchase of government bonds.  These bonds typically are purchased with electronic cash that did not exist before. The new money swells the size of bank reserves in the economy by the quantity of assets purchased.  In the short run, these central bank purchases lower interest rates and may encourage banks to make more loans.

However, this injection of more money into the economy may cause inflation.  An expanded money supply also could devalue, or weaken, the currency.  A devalued currency increases the prices of foreign products since consumers must give up more of their currency to buy these products. A devalued currency also reduces the attractiveness of foreign investments.  For example, if an investment earns 12 percent in a year but the value of the country’s currency  depreciates by seven percent, the foreign investor is left with only five percent.