Introduction
In economics, a budget deficit is the excess of expenditure over income for a given entity in a certain fiscal year. It, therefore, occurs when more is spent than what is earned. On the other hand, when an entity’s income exceeds its expenditure, it is said to have a budget surplus. Amadeo (2010, 1) defines budget deficit about US federal government as government spending over its annual revenue for a certain year. This is economically referred to as government budget deficit as it relates to government spending and revenues. Nearly all countries in the world have budget deficits every fiscal year as their expenditure surpasses revenue.
For many countries, these deficits have accumulated for years leading to what is called government debt. Governments with government debts resort to borrowing money, mostly from the public, to service the debt.
Governments borrow money from the public through the issuance of government bonds, bills, and other securities thus exposing the government to what is referred to as public debt. Public debt also referred to as national debt is the aggregated of all securities issued by the government to individual investors or institutional investors to raise money to finance government debt. The US definition of national debt includes all securities issued by the treasury to institutions and excludes intra governmental debts. If we include the intragovernmental obligations, we apply another term called gross debt. The US gross debt stood at 87.3% of the total gross domestic product (GDP) by March 2010.
This paper studies in-depth, the government budget deficit and national debt to real economies. The paper concentrates on the relationship between the two terms and their effects on the economy. Finally, we will look at methods used to finance government deficits.
Relationship between government budget deficit and national debts
This section focuses on the US economy as the point of reference. As defined earlier, the US federal deficit occurs due to the US government’s annual budget exceeding its revenue for a certain fiscal year. The US budget deficit was recorded as 1.57 trillion US dollars in the fiscal year 2010 but is projected to decline slightly by about $0.303 trillion in the fiscal year 2011 (Wieczorek, 2004, 1). The federal debt for the US government has been increasing over the past couple of years. It is currently above $12 trillion and this might go up in the next fiscal years. In the fiscal year 2000, the debt was $6 trillion indicating that it has grown by over 50% over the last decade.
Effects of deficits on debts
The two terms are inseparable as the growth of one affects the growth or the other. For instance, the growth of government deficit every year grows the debt by the same margin (Montgomery, 2009, 1). This is because if government experiences a deficit in a certain year, it borrows money to finance it and therefore the debt grows. In the event of a deficit, the treasury resorts to selling treasury bonds to close the deficit thus creating public debt.
It is called public debt because the treasury bonds are sold to the public for the government to raise money. At times the money raised through treasury bonds is not enough to close the deficit and therefore the government may borrow from itself through its account securities. This form of borrowing mostly from the social security funds is ignored in the calculation of public debt but in a real sense, the money will have to be repaid in the future. This further grows the debt although it is covered on allegations that it is just government internal transfers and not public debt. When the time comes for the retirees to claim their savings on social security funds, the government will pay what it borrowed.
Effects of debts on deficits
The debts also have significant effects on deficits as pointed out by Amadeo (2010, 1). Firstly, the true figure of the government deficit in any given fiscal year is well explained by the debts it seeks to borrow that year. Precision is attained in determining the deficit in a particular year by comparing the debt for the current year with that of the previous year. This method of estimating the actual deficit is reliable because it takes into account the government borrowing from social security funds which is mostly assumed away (Watkins, 2005, 1). Statistics have it that the US total debt has been on the upsurge from 2003 fiscal year to 2009.
It is recorded that the annual increase has been above 500 billion US dollars on average between 2003 and 2009 (Montgomery, 2009, 1). The highest changes were recorded as one trillion US dollars and 1.9 trillion US dollars in 2008 and 2009 respectively indicating that the deficit has been growing. Considering the debt for 2008 and 2009, we can claim that the actual deficit for 2009 was around $0.9 trillion ($1.9-$1 trillion) plus what was borrowed from the social security fund that year (Edge, 2007, 1). Without taking into account the amount borrowed from social security funds, it is hard to compute the actual government liabilities.
The second effect is that the deficit for every fiscal year incorporates interest on debts accumulated. Therefore interest on debts increases the government budget deficit each year because it is added to the budget as government liabilities. Thirdly, a persistent increase in US federal debt increases the risk perceived by the lenders making them raise the cost of borrowing. The result is that the government liabilities about debts increase thus increasing the budget deficit. This will hamper economic growth as the US government will be spending a lot of money every fiscal year in repaying the debts.
Effects of debts and deficits on economic growth
Deficit spending is considered a way of stimulating economic growth but it proves more harmful in the long run. Deficit spending in a recession is considered healthy for an economy. In the long run, however, the interest payable on the debt becomes a heavy burden for the economy resulting in slow economic growth (Wieczorek, 2004, 2). The US government may choose to devalue its dollars through deliberate action to make repayment of debt cheaper. This turns out to be more detrimental to the economic growth because the demand for treasury bonds goes down making their prices fall and interest rates increase. The government might be unable to issue bonds at those high-interest rates because it is expensive.
According to Wieczorek (2004, 1), the debt owed by the government to social security is repayable when beneficiaries retire. Paying these debts will increase government spending and deficit. The government might increase taxes to raise money to pay the social security debts; this will slow economic growth. The government will also not be able to borrow again from the social security fund but is expected to repay the debts. This will mean more burdens on the US economy and slow economic growth.
Methods of financing government budget deficit
Deficit financing is the attempt by the government to raise funds that will help match its budget and revenues for a particular year. There are three broad available methods of financing the deficit. These are borrowing, use of surplus, and minting money. The latter has been ruled out by economists on allegations that it causes inflation. The use of surplus can be the best method of financing deficit but very few countries have surplus budgets. The method entails using the surplus for a certain year to finance the deficit of another (Edge, 2007, 1). The only available method for many countries is borrowing but it is very detrimental to economic growth in the long run. Borrowing may entail selling treasury bonds, borrowing from international financial markets, borrowing from social security funds among others.
Conclusion
Government deficit and debts play a big role in the economic growth of a country. They are closely related and one cannot be addressed without touching the other. Governments try many methods to finance the deficit or repay the debt mostly through borrowing. If governments can manage to close their budget deficits through methods other than borrowing, they can be relieved of the national debt.
Reference List
Amadeo, K. (2010). About. US economy guide: how the US federalsDebt and Deficit differs and how they affect each other. London: the New York Times Company. Web.
Edge, k. (2007). Charles Stuart University. Department of education and training: Methods of financing the deficit and use of a surplus. Australia: Charles Stuart University. Web.
Montgomery, L. (2009). washingtonpost.com: Deficit projected to swell Beyond earlier estimates. US: Washington post company. Web.
Watkins, T. (2005). The deficit of the government. USA: san José state university Economics department.
Wieczorek, M. (2004). National Budget, Debt $ Deficit. Washington: Marktaw Company. Web.