Fiscal Policy: Budget Balances & National Debt (AQA A Level Economics)

The Budget Balance & National Debt

• The Government Budget (Fiscal policy) is presented each year as a balanced budget, a budget deficit, or a budget surplus

  • A balanced budget means that government revenue = government expenditure

  • A budget deficit means that government revenue < government expenditure

  • A budget surplus means that government revenue > government expenditure
    

• A budget deficit has to be financed through public sector borrowing

  • This borrowing gets added to the national debt (the cumulative total of past government borrowing which has to be repaid with interest)

  • Keynesian economists believe that the government should ‘run a budget deficit’ to finance spending and stimulate economic growth 

    • However, this increasing debt puts a greater burden on the population that will have to repay it in the future 

Cyclical & Structural Budget Deficits & Surpluses

• A cyclical budget deficit or surplus is related to the economic cycle and aggregate demand 

  • During a boom, there is an improvement in the government budget as tax revenues rise and expenditure falls, decreasing the deficit

  • During a recession, there is an increase in government expenditure, leading to a greater budget deficit

    • A cyclical deficit could then be corrected when the economy recovers again through the impact of automatic stabilisers
      

• A structural budget focuses on the long-term underlying fiscal position of the government, independent of the effects of the business cycle

  • It aims to assess whether government revenues are sufficient to cover ongoing expenditures over the long term, without considering temporary fluctuations in economic activity

  • Structural budget analysis often involves evaluating the sustainability of government policies and the need for fiscal adjustments to ensure long-term fiscal stability

  • For example, an increase in an ageing population will require the government to spend more on pensions and healthcare

    • If this expenditure is greater than revenue, it is added to national debt and is called a structural budget deficit 

    • Correcting a structural budget deficit resulting from excessive borrowing is challenging 

    • Governments need to increase taxes and cut public spending (austerity measures) which can negatively impact economic growth and employment

Consequences of Budget Deficits & Surpluses

Consequences of a Budget Deficit

• Many countries continue to run a budget deficit year after year

  • A deficit must be financed through borrowing from somewhere

    • Borrowing from outside the country (external borrowing) may cause political vulnerabilities

    • Singapore only borrows from its own citizens (internal borrowing), which reduces the risk of external pressure on their policies

Diagram: Consequences of a Budget Deficit

Running a budget deficit enables a government to spend more than it receives
 

Explaining the Consequences

Consequences of a Budget Surplus 

• A budget surplus can be used to reduce general government debt and reduce future costs of servicing the debt

  • A surplus can be set aside for future economic shocks e.g. the Covid 19 crisis
    

• However, a surplus may mean that the government withdraws (higher taxes) more money than it injects (less spending)

  • A surplus may then reduce economic growth and also reduce pressure on prices levels leading to disinflation or even deflation
    
    

The Significance of the Size of the National Debt

• A budget deficit has to be financed through public sector borrowing

• This borrowing gets added to the national debt

  • The size of the UK’s national debt increased significantly during the Covid pandemic 

Debt to GDP Ratio 

• A Debt to GDP ratio measures the size of a country’s debt in relation to size of the country’s economy

  • A high Debt to GDP ratio creates vulnerabilities

The Significance of Large National Debt

The Role of the Office for Budget Responsibility

• The Office for Budget Responsibility (OBR) was established in 2010

• The primary responsibility of OBR is to manage public sector finances 

• Other responsibilities include: 

  • Providing detailed forecasts on the current economic performance

  • An analysis of UK public spending and taxation

  • Assesses the performance of the government against the fiscal targets set

  • Advises government on economic predictions to aid with future policymaking 

  • Uses long-term projections to analyse sustainability of government spending and revenue