Budget Deficits and Public Debts

Government Debt and Deficits
Government debt is the stock of outstanding IOUs issued by the government at any time in the past and not yet repaid. Governments issue debt whenever they borrow from the public; the magnitude of the outstanding debt equals the cumulative amount of net borrowing that the government has done. The deficit is the addition in the current period (year, quarter, month, etc.) to the outstanding debt. The deficit is negative whenever the value of outstanding debt falls; a negative deficit is called a surplus.

Budget Deficit
Excess of spending over income for a government, corporation, or individual over a particular period of time. A budget deficit accumulated by the federal government of a country must be financed by the issuance of Treasury Bonds. Corporate deficits must be reduced or eliminated by increasing sales and reducing expenditures, or the company will not survive in the long run. Similarly, individuals who consistently spend more than they earn will accumulate huge debts, which may ultimately force them to declare bankruptcy if the debt cannot be serviced. The opposite of a deficit is a surplus.

Federal Debt
A good way of judging the size of the federal debt, and hence its likely effect on the economy, is, as for an individual, to take it as a ratio of income. For example the federal debt of the United States reached a peak ratio of 114 percent of GDP after World War II and declined to 26 percent by 1981, before rising again. But even with the subsequent deficits, it was still only 51 percent of GDP in 1992. True "balance" in the budget, would entail not a zero deficit, but one such that the debt grows at the same percentage rate as GNP, thus keeping the debt-to-GNP ratio constant.

Federal Deficit
Those concerned about large deficits usually argue as follows: deficits let current generations off the hook for paying the government's bills. Therefore, current generations consume more. This reduces the amount citizens save and invest. A reduced rate of investment means less capital per worker and, therefore, lower productivity growth. When capital is scarce, its rate of return rises, causing interest rates to increase. Higher interest rates attract foreign investment to that country.

The simple fact is that the deficit is not a well-defined economic concept. The current measure of the deficit, or any measure, is based on arbitrary choices of how to label government receipts and payments. The government can conduct any real economic policy and simultaneously report any size deficit or surplus it wants just through its choice of words. If the government labels receipts as taxes and payments as expenditures, it will report one number for the deficit. If it labels receipts as loans and payments as return of principal and interest, it will report a very different number.