A decrease in budget deficit will not lead to a fall in public debt.

Introduction

A budget deficit occurs when government expenditure exceeds government revenue. Public debt refers to the amount of money that the government owes. It is also known as national debt, sovereign debt and government debt.

Many students think that a decrease in budget deficit will lead to a fall in public debt. There will be a discussion on this economic misconception in economics tuition at Economics Cafe.

Exposition

When the government runs a budget deficit, it will borrow by issuing securities (i.e. bonds and bills) to finance the deficit, assuming it does not have sufficient reserves. When this happens, the public debt will rise. A decrease in budget deficit may occur due to a decrease in government expenditure, an increase in government revenue, or both. Many students think that a decrease in budget deficit will lead to a fall in public debt. This is erroneous. When the budget deficit falls, the public debt will not fall. Rather, a decrease in budget deficit will lead to a slower rise in the public debt. This is because when the government runs a smaller budget deficit, what it means basically is that it will borrow a smaller amount of money to finance a smaller budget deficit. It follows that the public debt will continue to rise, albeit at a slower rate. A natural question is, what will lead to a decrease in the public debt? The public debt may fall when the government runs a budget surplus. A budget surplus occurs when government revenue exceeds government expenditure. The excess of government revenue over government expenditure may be used to redeem some of the public debt through the purchase of government securities by the government itself. If this happens, the public debt will fall. A good understanding of the relationship between the government budget and the public debt is of great importance in the examination. This is particularly true when the question requires students to discuss the effects of austerity measures on the economy.

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