When Expansionary and Contractionary Fiscal Policy spends more than it collects, the government borrows the difference. Two words describe this, and they are easy to mix up: one measures a year, the other the total.
Key idea
The budget deficit is one year's shortfall: spending (purchases, transfers and interest) minus revenue. A surplus is the reverse. The national debt is the total amount the government owes: the running sum of past deficits minus past surpluses. The deficit is a flow; the debt is a stock.
Why it works
Think of a bathtub. The water level is the debt; the water pouring in each year is the deficit. As long as water flows in, the level rises, even if the faucet is turned down. A smaller deficit means the debt grows more slowly, not that it falls. The level goes down only when water drains out: a surplus. Economists often compare the debt with GDP, because a larger economy can carry a larger debt.
Worked examples
Worked example: Deficits into debt
The debt starts at \$8,000 billion. Deficits are \$500 billion, then \$300 billion; then there is a \$100 billion surplus. What is the debt after three years?
- Add the deficits and subtract the surplus.
- $8{,}000 + 500 + 300 - 100 = 8{,}700$ billion dollars.
Answer: \$8,700 billion
Worked example: Shrinking deficit, growing debt
Last year's deficit was \$700 billion; this year's is \$400 billion. What happened to the debt this year?
- There was still a shortfall of \$400 billion, which the government borrowed.
- The debt rose by \$400 billion, more slowly than last year, but it rose.
Answer: It rose by \$400 billion
Worked example: Debt compared with GDP
The debt is \$24,000 billion and GDP is \$30,000 billion. Find the debt-to-GDP ratio.
- $\dfrac{24{,}000}{30{,}000} \times 100 = 80\%$.
- If GDP grows faster than the debt, this ratio can fall even while the debt rises.
Answer: 80%
Common mistake
Using deficit and debt as the same word, or thinking a shrinking deficit means the debt is falling. Check: is there still a shortfall this year? Then the debt is still rising.
See it with real data: U.S. federal debt as a percent of GDP on the Economic Data page.