Debt Ratio - Explanation

Governments generally have to borrow money. This happens because they tend to spend more than they receive in tax revenue. As with any individual who spends more than they earn, the government has to borrow to fill the gap. This borrowing is known as the public sector net cash requirement (PSNCR). There is an extensive range of resources in the Virtual Economy on the PSNCR.

The PSNCR increases, each year, the amount that the government owes. The total amount that the government owes to people and financial institutions is called the national debt. This will increase each year by the amount of the PSNCR and reduce by the amount that is paid off. For more detail on this relationship see the debt ratio theory section. The national debt is measured in billions of pounds (£bn), but we often need to know the significance of this level of debt. To measure this we take the national debt as a percentage of GDP, which is known as the debt ratio. The higher this percentage the more significant the debt is to the economy. This would be just the same for an individual. A debt of £5,000 would be very significant to someone earning only £10,000 - it would be a high percentage of their income. However to someone earning £50,000 it would be much less important. It is therefore the size of the debt compared with income that is important, not the size of the debt itself.

The debt ratio is important because the higher the debt ratio, the higher the interest payments that the government has to make. This takes up money that could be spent on providing other public services.

Why not also have a look at the relevant theories about the debt ratio, or have a go at a worksheet about it?