Government Aims and Fiscal Policy: Question 10
Syllabus 4.2
The government of Rennick has run a budget deficit every year for the past five years, and each year's deficit has added to the total amount the government owes.
Which statement correctly distinguishes Rennick's annual budget deficit from its national debt?
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Worked solution
Step 1: Define the two terms
A budget deficit is a flow: the shortfall between government spending and tax revenue over a single period, usually one year. A national debt is a stock: the total amount the government owes at a given point in time, built up from the accumulation of past budget deficits (reduced by any budget surpluses along the way).
Step 2: Apply this to Rennick
Each year, Rennick’s government spent more than it collected in tax revenue, creating that year’s budget deficit. To cover each year’s shortfall, the government borrowed, and this borrowing did not disappear at the end of the year, it added to the running total the government owes. After five years of deficits, the national debt is the sum of all five years’ deficits (net of any surpluses in between), not just the size of the most recent one.
Step 3: Why the other options are wrong
- A: swaps the two definitions, describing the deficit as a stock and the debt as a single year’s flow.
- C: treats the two measures as identical, ignoring that a deficit is measured over one year while the debt is an accumulated total.
- D: confuses the deficit with a budget surplus, and misstates what the debt measures.
Final answer
The budget deficit is the annual shortfall between spending and revenue, while the national debt is the accumulated total of past deficits still owed, option B.