The objective of the thesis is to create an understanding of the mechanics behind public debt. This involves examining how it is possible for a country to have a reasonable deficit in its yearly financial balance over an indefinite amount of time, and still maintain a sustainable debt to Gross National Product (GNP) ratio. This is in particular determined by the relation of interest on national debt compared to the growth rate of GNP, as whenever the growth rate exceeds the interest rate, the total debt amount will decline even if the yearly balance has a deficit. As this revelation shows that public debt by itself says very little about the economic situation by itself, the thesis goes on to briefly elaborate on several concepts related to the effects of public debt, including long-term financial sustainability, the differences between the actual and structural public balances and cyclical effects including the output gap. It then goes on to examine the financial goals Denmark are obligated to reach as part of the EU, along with the consequences of an eventual failure to reach these goals. Finally, the first chapter attempts to determine which levels of public debt-to-GNP ratio starts to affect a country negatively, but as of now, no clear answer exists. The reason for this is that the trustworthiness of a country in regards to fulfilling its obligations are what determine when debt affects the economy. When debt reaches a level where investors feel uneasy about a country’s ability to pay back their debts, they start demanding a risk premium in the form of increased rates on treasuries. As investors determine when such a level has been reached, it is exceedingly difficult to state a specific debt-to-GNP level as being critical, as several factors aside from that level should be considered when investors determine the trustworthiness of a country. The goals determined by the EU however are rather conservative compared to several estimates of the critical ratio, and as Denmark is especially strong in regards to this particular ratio, it seems highly unlikely Denmark will see financial troubles due to its debt levels. The second part of the thesis is an analysis of the current Danish economic climate, mostly based on the findings of Det Økonomiske Råd, who serves as a watchdog over Danish fiscal policy. This analysis finds that Denmark since the fiscal crisis has experienced slow GDP growth levels, but otherwise follows a fiscally responsible policy in the long term, where only the structural balance seems at risk of getting close to reaching critical levels in the foreseeable future. Of particular note, the so called “hammock-issue” where the public balance is due to show a considerable deficit in the long term due to demographic shifts is shown to have a lesser effect on the sustainability of the Danish economy than one might normally expect. The biggest potential risk to the Danish economy instead seems likely to come from international politics, where a shift towards protectionistic rhetoric and the relative success of anti-EU political parties could negatively affect international trade levels, with the fate of the Trans-Pacific Partnership Agreement in particular being uncertain due to recent election results in the US. The third and final part of the thesis examines the low Danish growth in relation to comparable countries and finds that GDP growth is in fact abnormally low in comparison to other countries. This is explained by a demographic variance where a larger part of the population in the work-eligible age group are in the younger segment likely to be undertaking an education in comparison to other countries. This leads to a smaller GDP growth now, but a potentially higher one in the long term. Low growth in production is also part of the explanation, though this is to be expected due to Denmark’s status as a highly developed country, and political steps have been taken to address this problem. The analysis also finds that focusing on GDP growth alone can be misleading, as Denmark has performed very well in regards to the trade balance since the fiscal crisis, resulting in both considerable gains when comparing the rise of prices on export compared to imports. This development has also led to a considerable increase in interest income from a due to a sharp rise in foreign assets compared to foreign debt.
1 dec. 2016
Aarhus University. BSS. Department of Economics and Business Economics