Government Debt and Budget Deficit

Government debt is the total amount the government owes to lenders, such as households, businesses, financial institutions, and foreign governments, among others.

To understand government debt, we start with the budget deficit.

Imagine an economy where the government expects to collect three trillion dollars in revenue but plans to spend three and a half trillion dollars. The projected budget deficit is five hundred billion dollars at the end of year one.

To cover the shortfall, assume the government borrows money by issuing bonds. At the end of year one, the government’s debt is five hundred billion dollars, assuming this is the first time the government has borrowed.

The next year, the government again had a budget deficit of three hundred billion dollars. So, the government borrows this amount from lenders by issuing bonds.

At the start of year two, the government’s debt is five hundred billion dollars. The three hundred billion dollars borrowed during year two brings the debt to eight hundred billion dollars by the end of the year.

In short, a budget deficit shows a shortfall of revenues from expenditure in a year, while government debt is the total amount the government has borrowed