If a government runs a budget deficit of $10 billion dollars each year for ten years, then a surplus of $1 billion for five years, and then a balanced budget for another ten years, what is the government debt?

Total budget deficit = $100 billion dollars Total budget surplus = $5 billion dollars Debt = Total deficits - Total Surplus = 100 - 5 Debt = $95 billion The debt of this government is $95billion.

which demographic trends would result in government deficits?

When lots of older people retire and draw government benefits, there are fewer people in the workforce providing revenue in the form of taxes. This is happening to Japan currently and will affect the U.S. in the future

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Course: Macroeconomics > Unit 5

Lesson 5: Deficits and debts

Lesson summary: Deficits and debts

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In this lesson summary review and remind yourself of the key terms and graphs related to deficits and debts.

Summary

We've learned that expansionary fiscal policy, such as decreasing taxes or increasing government spending, can be a powerful tool to fix a recession. But just like you, if a government’s spending exceeds its income, it has to borrow the difference.

When a government's expenditures on goods, services, or transfer payments exceed their tax revenue, the government has run a budget deficit. Governments borrow money to pay for budget deficits, and whenever a government borrows money, this adds to its national debt.

Key terms

Key term	Definition
balanced budget	when a government's spending on goods, services, and transfer payments equals its tax revenues
budget deficit	when a government spends more on goods, services, and transfer payments than it collects in tax revenues; budget deficits add to the national debt
budget surplus	when a government spends less on goods, services, and transfer payments than it collects in tax revenues; budget surpluses can be used to pay down the national debt
national debt	the accumulated amount of money that a government owes to its creditors as the result of running budget deficits
transfer payments (aka implicit liabilities)	payments by the government that are not in return for goods and services; for example, when the government of Hamsterville pays a grandmother a retirement pension, they are transferring money to her, rather than buying goods and services from her.

Key takeaways

Deficits occur when government spending and transfer payments exceed tax revenues

If a person finds that they are spending more money than they have, they will either need to sell off some of their belongings or borrow money. The government faces the same problem. The money that the government has to spend is the money it collects in the form of taxes; if that isn't enough to cover its spending, the government has run a deficit and will have to borrow money.

What does the government spend money on? Governments spend money on goods and services, such as computers for government employees and payments to government contractors. Additionally, governments frequently have legal obligations to make payments to individuals, such as social security retirement payments in the United States.

When a government borrows money, its debt increases

Whenever a government runs a budget deficit, it adds to its long-term debt. For example, suppose the government of Kashyyyk has a

$ 200

million budget deficit one year, so it borrows money to pay for its budget deficit. The next year the government runs another deficit, this time of

$ 100

million. Now the government has accumulated a debt of at least

$ 300

million.

Government debt reduces the ability of a government to spend in the future

Notice that we said that the government has accumulated a debt of at least

$ 300

million in the last example. If you are asking yourself, "but doesn't

$ 200

million plus

$ 100

million equal

$ 300

million exactly?", then you are forgetting an important aspect of debt: interest.

Just like anyone else borrowing money, governments have to pay back both the amount of a loan and interest on that amount. For example, if Kashyyyk's loans accrue

10 %

interest each year, then at the end of the first year it now owes:

\begin{aligned} Debt at the end of the year & = Amount of loan + amount of interest \\ = $ 200 million \times ($ 200 million \times 10 %) \\ = $ 200 million \times $ 20 million \\ = $ 220 million \end{aligned}

So, if the government doesn't pay down any part of the amount borrowed in the first year or the interest, the total accumulated debt when it runs a deficit the second year is

$ 320

million.

Debts must be repaid. That means that if the government of Kashyyyk wants to repay that debt, it will have to stop running deficits and start running surpluses. A government will have to begin to reallocate spending away from goods, services, or transfer payments and toward paying down its debt.

Technically, yes, a government could print money to pay off its debt. However, that can have some pretty negative consequences, such as inflation or even hyperinflation.

An excellent example of how this can go terribly wrong is the Hungarian inflation of 1946 which has the dubious distinction of being the worst recorded hyperinflation in human history. Following World War II, Hungary's infrastructure and industrial capacity was mostly destroyed, which meant that the government had basically no ability to collect taxes. The Hungarian government decided to print money to pay for government spending.

The result was that, at its 1946 peak, inflation reached

41,900,000,000,000,000 %

per month; a rate of inflation this high means that prices were doubling every 15 hours. For comparison, the inflation rate in Hungary in 2017 was close to

2 %

per year.

In short, most economists agree that this approach to paying for spending is generally a pretty bad idea.

There is a close relationship between the budget balance and the business cycle

Governments tend to run deficits during recessions and surpluses during expansions. Recall that automatic stabilizers tend to kick in when there are changes in output, which means that during recessions, government spending on things like transfer payments tends to increase at the same time that tax revenues decrease.

Key equations

Public savings is calculated as:

Savings by government = Tax revenue - Government spending - Transfer payments

For example, if a country takes in

$ 700

in tax revenue, spends

$ 600

on goods and services and

$ 200

in transfer payments:

\begin{aligned} Savings by government & = Tax revenue - Government spending - Transfer payments \\ = $ 700 - $ 600 - $ 200 \\ = - $ 100 \end{aligned}

Note that the savings here are negative. National savings can be positive, which would mean the government has money that it could loan out. However, negative national savings means that the government is borrowing money.

Common misperceptions

New learners sometimes get the terms "deficit" and "debt" confused. Deficit describes a one-time shortage (for example, in an annual budget), while debt describes a shortage that has accumulated over time, e.g. from multiple annual deficits
Many people assume that deficits are "bad," but an economist would remind those people that we tend to stick to positive analysis rather than normative analysis. A deficit might be the result of an event such as a recession which gets paid off the next time an economy experiences a boom (and a budget surplus as a result of that boom). However, running many deficits leads to debt, and debts must be repaid. That means that eventually paying a debt will limit what a government can spend in the future.

Questions for review

Suppose a government has a deficit in 2016 of $$ 100$ ‍ million and there is $$ 600$ ‍ million in national debt that it accrued before 2016. If the interest paid on debt is $10 %$ ‍, how much of a budget surplus will be necessary for 2017 to keep the debt from getting any larger? SHOW YOUR WORK.
When the government has a new deficit of $$ 100$ ‍ million, this will add to its pre-existing debt of $$ 600$ ‍ million, creating a new debt of $$ 700$ ‍ million:
$\begin{aligned} New debt & = Old debt + New deficit \\ = $ 600 + $ 100 \\ = $ 700 \end{aligned}$ ‍
That new debt will accumulate interest:
$$ 700 million \times 10 % = $ 70 million$ ‍
Therefore, the government would need to come up with at least $$ 70$ ‍ million by either raising taxes or cutting spending the following year to keep the debt from getting any larger.
If a government has a budget deficit, what are its options to return to a balanced budget?
Increase tax revenue (either from national income increasing or increasing the tax rate)
Reduce government spending on goods and services
Reduce transfer payments

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ngiffuni
Posted 2 years ago. Direct link to ngiffuni's post “If the total amount the g...”
If the total amount the government spends equals tax revenues in any given year. what has to stay constant?
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Claudita Li
Posted 4 years ago. Direct link to Claudita Li's post “If a government runs a bu...”
If a government runs a budget deficit of $10 billion dollars each year for ten years, then a surplus of $1 billion for five years, and then a balanced budget for another ten years, what is the government debt?
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- icsnmmesoma
  Posted 4 years ago. Direct link to icsnmmesoma's post “Total budget deficit = $1...”
  Total budget deficit = $100 billion dollars
  Total budget surplus = $5 billion dollars
  
  Debt = Total deficits - Total Surplus
  = 100 - 5
  Debt = $95 billion
  
  The debt of this government is $95billion.
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Joyce Kim
Posted 3 years ago. Direct link to Joyce Kim's post “which demographic trends ...”
which demographic trends would result in government deficits?
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- Peter Silvain
  Posted a year ago. Direct link to Peter Silvain's post “When lots of older people...”
  When lots of older people retire and draw government benefits, there are fewer people in the workforce providing revenue in the form of taxes. This is happening to Japan currently and will affect the U.S. in the future
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yogipatelyp58
Posted 3 years ago. Direct link to yogipatelyp58's post “what are the impact on wa...”
what are the impact on wages and profits of moving from a deficit to a surplus in the government budget?
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amos7054
Posted 3 years ago. Direct link to amos7054's post “A government starts off w...”
A government starts off with a total debt of $5.95. In year one, the government runs a deficit of $2.43. In year two, the government runs a deficit of $3.4. In year three, the government runs a surplus of $3.33. What is the total debt of the government at the end of year three?
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