Final answer:
The optimal debt level is determined through d)precise calculations, considering factors such as inflation, economic growth, and investor confidence in the government's ability to repay debts.
Step-by-step explanation:
The optimal debt level is determined through precise calculations and by considering various economic factors. It is not merely a matter of mirroring inflation or making a subjective decision. When a government borrows money at a fixed interest rate, say 5%, and inflation rises above that rate, it can effectively repay its debt with money that is less valuable, meaning a negative real interest rate. However, if a rising debt-to-GDP ratio causes uncertainty in financial and global markets, it can diminish real wealth and erode confidence in the government's fiscal management.
Countries may experience high inflation rates of, for example, 10% to 30% annually, and can still sustain solid economic growth by indexing contracts and interest rates to inflation, thus protecting purchasing power and living standards. Inflation can destabilize the economy by leading to a decrease in standard of living and diminished purchasing power for money lenders. The government's debt level is monitored and often debated by economists and politicians, taking into account the confidence that investors have in the government's ability to pay its debts.