What is... | July 21, 2011

What is a budget deficit?

When individuals spend more than they earn, they go into debt or deficit. At a country by country level, spending more than is earned is typically called a “budget deficit” – a term that has hit the headlines lately in connection with Eurozone economic troubles and debate over public finances in the United States.


Budget deficits rose during the global financial crisis
A government that raises €100bn over a financial year through taxes and other forms of revenue but that spends €110bn will record a budget deficit of €10bn. A deficit for one financial year will not necessarily cause trouble. But problems can arise when countries run large deficits for many years – and don’t reduce them when economic conditions improve. 
During the global financial crisis, budget deficits and national debt increased noticeably in many countries. International Monetary Fund (IMF) figures show the budget deficit for the US grew from 2.7% of gross domestic product (GDP) in 2007 to 10.8% this year and for the United Kingdom from 2.7% to 8.6%. Cash-strapped Greece already had a relatively high budget deficit, so its figure went from 6.7% of GDP to 7.4%. 
Expressing budget deficits as a share of the country’s GDP aids comparisons between nations. In a recession, factors driving the budget deficit growth typically include lower tax take amid slowed economic activity and higher government spending aimed at stimulating the economy.

“Budget deficits” are different to “national debts” 
There is nothing inherently dangerous with a country running a budget deficit, as the shortfall can generally be covered by borrowing that is paid back when conditions improve. In fact, higher budget deficits can be a way to offset periods of weakness in the economic cycle. Many economists believe that by spending money and amassing deficits in the wake of the latest global financial crisis, governments prevented recession becoming depression. A highly-regarded analysis on the Vox portal, for example, examined policy responses in the wake of the latest global financial crisis. If countries rack up a series of deficits, borrowings can compound and lead to problems. The total amount borrowed and yet to be repaid is known as the national debt.

When deficits cause problems
When budget deficits and national debts become larger than investors are comfortable with, problems can follow. If issuing bonds to raise money, for example, cash-strapped governments may be forced to pay higher interest rates to offset risk to investors of government default.

EconomicsEuropeDebt

Phil Thornton
Phil Thornton

Lead consultant at Clariti Economics

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