- The national debt to gross national product (GDP) ratio is calculated by dividing a nation’s federal debt by its economic output.
- That ratio serves as an economic barometer that can indicate whether a country is financially healthy.
- The U.S. debt-to-GDP ratio is uniquely important due to the United States’ role as a global economic powerhouse and the U.S. dollar’s role as the global reserve currency.
- However, the debt-to-GDP ratio isn’t the only factor to consider when assessing a country’s economic stability and can be misleading on its own.
You often hear politicians, journalists, and economists referring to the national debt-to-GDP ratio. But what exactly does the term mean, and why is it so important?
The term is best understood by its two parts. First, the national debt is exactly what it sounds like: the total amount of money the federal government owes its lenders. The U.S. Treasury calculates that amount to the penny every business day, and as of this writing that number is $30.4 trillion.
The national GDP is the estimated value of all the goods and services produced in the United States. The number is estimated quarterly and annually by the U.S. Bureau of Economic Analysis. The GDP is a number that investors and taxpayers can look at to get a sense of how the economy is doing. When the GDP rises, it’s a sign of a healthy and growing economy, and when it falls, it shows that the economy is shrinking—a negative trend.
To get a country’s debt-to-GDP ratio, you simply divide the national debt by the national GDP. The resulting percentage is what we’re referring to as the national debt-to-GDP ratio. As of the fourth quarter of 2021, according to the Federal Reserve Bank of St. Louis, the U.S. debt-to-GDP ratio was 123.39%.
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What the U.S. Debt-to-GDP ratio means
Similar to how a debt-to-income ratio can serve as a way to judge your individual financial health, the debt-to-GDP ratio can be a useful tool for judging the financial health of a country. A number above 100% means the dollar amount of the debt is greater than the dollar amount of the GDP. A number below 100% means the dollar amount of the GDP is greater than the dollar amount of the debt—a good economic sign.
When a country has a lot of debt and at the same time isn’t producing valuable goods and services, that’s bad news. This simple formula of dividing debt by GDP can be very helpful in determining at what point a country’s debt starts to drag down its economy.
“A smaller ratio typically indicates a country’s ability to repay their debt, which reduces the concerns over future default, while a higher ratio raises concerns of a future default,” says Kevin Jones, director of treasury advisory and corporate at Chatham Financial.
Those worries of default—that is, a country not being able to repay their debts—are what makes the debt-to-GDP ratio so impactful. In fact, the World Bank, an international financial institution, found that 77% is the exact point where the debt-to-GDP ratio negatively impacts a country’s economy. If a country’s debt-to-GDP ratio is 77% or higher, their economy is more likely to slow down and suffer because of the amount of debt.
Is it an effective measurement?
Economists disagree on whether a straightforward interpretation of a country’s debt-to-GDP ratio is actually a solid way of measuring that country’s economic health. For instance, many of the countries with the “best” debt-to-GDP ratios (very low percentages) have those numbers only because no other country will lend them money, including:
Democratic Republic of the Congo: 15.2%
Meanwhile, the U.S. has one of the highest debt-to-GDP ratios in the world but remains one of the most dominant economies globally.
The U.S. debt-to-GDP ratio has been climbing steadily since its record low of 30.6% in 1981 and hit a record high of 135.93% in 2020 as a result of COVID-19 spending.
Tip: While the debt-to-GDP ratio is an important number, it’s far from the whole picture of a country’s economic health. Countries with “bad” debt-to-GDP ratios can be doing very well, while countries with “good” debt-to-GDP ratios can be economically unstable.
It’s clear that while the debt-to-GDP ratio is a helpful guide, that single number isn’t the whole picture. Wealthy countries with a large economic output can carry a larger debt-to-GDP ratio without triggering concerns of whether or not they can pay it back—much like how a wealthy individual is likely to still be able to borrow at attractive rates even if they already have a lot of debt.
How is the U.S. debt-to-GDP ratio different from other countries’?
The U.S. debt-to-GDP ratio is very unique in two ways:
First, the U.S. dollar has been the world’s reserve currency since 1944. (Simply put, reserve currency is foreign money that countries hold in case of emergencies. They can then use this reserve if their own currency starts to drop in value, for instance.)
The second way the U.S. debt-to-GDP ratio is unique is tied to its use as global reserve currency: The United States has had the world’s largest and most dominant economy for years.
Because of the scale of the U.S. economy and the dominance of the U.S. dollar, the U.S. debt-to-GDP ratio is very important to the global economy. According to the World Bank, as of 2020 the United States made up approximately a quarter of global GDP. That means that the U.S. creates roughly 25% of all the goods and services produced and purchased around the world—a huge chunk of the world’s GDP.
The relationship between a country’s debt and its GDP is more complicated than it might seem at first, but it can still tell us a lot about that country’s economy. And as long as the United States continues to be one of the most dominant economies globally, the world will look to its debt-to-GDP ratio to predict which way the international economy is heading.
What the U.S. debt-to-GDP ratio means for you
The national debt is certainly an impactful number, and the U.S. national debt ballooned during the COVID-19 pandemic with government initiatives spending money in order to help businesses and individuals stay afloat. But how does the country’s debt-to-GDP ratio affect you?
“The debt-to-GDP ratio impacts a country’s citizens because a nation has to balance its borrowing ability with its output—too much borrowing means that future borrowing will have a higher cost,” Jones explains. “The more creditworthy a nation is, the more efficiently they can borrow. When a country borrows too much at a higher cost, it can mean that the country will have less funds to provide government services to its citizens.”
When it becomes more expensive for a country to borrow, it can also impact its crisis response—whether that crisis is natural, economic or something else entirely—because of the limited funds. The National Bureau of Economic Research found that in general, countries with lower debt-to-GDP ratios respond better to crises, recovering more quickly and losing less economic output than countries with higher ratios.
The debt-to-GDP ratio is a much-examined measurement for a reason. By understanding what it means and its complexities, you can get a sense for where the economic winds are blowing and what our financial future might look like.