Deficits and debt | AP Macroeconomics | Khan Academy

Two terms that you've likely heard in the context of government spending, budgets, and borrowing are the terms deficit and debt. They can get a little bit confusing because they're associated with borrowing in budgets and spending, and they both start with "d." They are related, but they mean different things.

A deficit is a situation where you spend more than you are taking in. So, from a government point of view, this would be a situation where a government spends more in a year than they take in in revenue in that year. In a year or budgetary cycle, spending more than taking in, and that difference—the amount that you are overspending that year—is going to be a deficit.

A debt, on the other hand, is the total amount that you owe. Now these are clearly related. Let's say, let me make a hypothetical government here. So, let's say year one, year two, year three, year four, I'll go up to year five, and let's think about the deficit each year and let's think about the debt each year.

So, let's say in year one, our hypothetical country overspend by 200; I'll do everything in billions of dollars. So we overspend by 200 billion dollars; we run a 200 billion dollar deficit. Well, assuming that the debt was zero before that, we're now going to owe people 200 billion dollars. I'm assuming everything here is in billions.

All right, so let's say the next year we run a deficit of 100 billion dollars. Well, now we owe the money that we owed before plus another 100 billion dollars, so this would be 300 billion. You can see where this goes. If in year three we run another deficit of, let's say, we spend a lot this year, a lot more than we take in, so we have a deficit of 500 billion. Well, then that will just add to our debt, so it's now going to be 800 billion.

Of course, you can pay down debt. In order to pay down debt, you would run a surplus in a year, which you could view as a negative deficit. So, let's say that this year it's negative 100. Normally, people wouldn't say this is a negative 100 billion dollar deficit; normally, they would say that the government ran a hundred billion dollar surplus.

But let's say they run that surplus; they pay down the debt. Well, now they would pay it down, so now we owe 700 billion. Of course, you could have a year where you have a completely balanced budget—you're not running a surplus or a deficit—and in that case, your debt would stay the same.

Now, some of y'all might be wondering about the interest. But the interest on the debt, that would be part of the budget. So we thought about that already on whether we're running a surplus or a deficit. To make this a little bit more clear in the context of the United States, here is a chart that shows the total deficits and surpluses for the United States from the late 1960s all the way to near the present time. But then it projects out a decade, and these projections you should always take with a grain of salt.

Whenever these bars are going downwards, those are years in which our government is running a deficit. The years where we are above the line, those are where we are running a budget surplus, where the government actually took in more than it spent. So, big picture deficits and surpluses are talking about how much you are over or under spending in a given year, while debts are talking about your accumulated amount that you owe.

To make that clear, we can take a look at the total public debt in the United States, and this once again goes from the 1970s all the way to near the present. You can see that the debt has accumulated in a pretty big way; it's approaching—this says 20 million—but you have to look at this; it says millions of dollars, so this is 20 million million or 20 trillion dollars of debt. This is how much the United States government owes.

But some of you might argue that "Hey, look, the economy has grown a good bit," so what really matters is how much do you owe as a percent of GDP. So this shows, as a percentage of GDP, it's not quite as dramatic. But our government debt is now about equal to our annual GDP. So if you were to make an analogy to your personal life, if you say made a hundred thousand dollars in a year, this is like having also a hundred thousand dollars of debt.

Now an interesting question is what are the pros and the cons of running a deficit in a given year, which is going to add to the debt? Well, some of the arguments in favor of sometimes running a deficit—which will add to the debt—is that it allows a government to do counter-cyclical fiscal policy or, if you're into a recession, to have an expansionary fiscal policy, which we've talked about in other videos.

Often involves maybe lowering taxes and increasing spending, and that could allow the government to maybe make a recession less severe, which might allow everyone to be better off in the long run. And these things are all debated.

Now the cons are easier to think of. One could imagine that at some point the debt becomes unsustainable—debt unsustainable—and there are definitely examples of other countries that have run such large debts that they could not even service the interest. Remember, whether it's just you individually or the government, when you borrow money, you have to pay interest.

At some point, the interest could become so significant that the government can no longer afford to pay it. Even if a government can pay the interest on the debt, that money that's being used for interest could have otherwise been used for other things.

Another con of running large deficits, which could lead to large accumulated debts, is that it can affect interest rates in the broader market. So you could lead to an increase in interest rates. When we study the money market, we would see that, "Hey, the more that the government is out there trying to borrow money, that's going to shift demand in the money markets to the right."

If the interest rates increase, that could lead to what we've talked about before, the idea of crowding out or the crowding out effect, where, because of increased interest rates, fewer potential private borrowers are going to go and borrow money, which they might use to go out and invest things.

So these are all very interesting things to think about. But the big takeaway here is to not get confused between deficit and debt. Deficits and surplus refer to how much you are over or under spending in a given year; debt is the total amount you owe.