📒 Budget Deficit, Surplus, and National Debt
- Budget deficit.
- Budget surplus.
- National (public) debt.
Key distinction
The deficit is a flow (this year's shortfall). The debt is a stock (total owed over time). A government can have a small deficit but a large debt built up over decades.
Real-world context: Japan's national debt exceeds 260% of GDP — the highest in the developed world. The US debt surpassed $34 trillion in 2024. Both countries ran persistent deficits, especially after 2008 and COVID-19.
⚙️ Automatic Stabilisers
Automatic stabilisers.
How they work
- In a recession: incomes fall → people pay less income tax AND more people claim unemployment benefits → disposable income is cushioned → C doesn't fall as much → AD contraction is softened.
- In a boom: incomes rise → people pay more income tax AND fewer claim benefits → disposable income growth is constrained → AD expansion is softened → reduces inflationary pressure.
Automatic stabilisers kick in without any policy decision — they are built into the system. Discretionary fiscal policy, by contrast, requires deliberate action by the government.
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⚖️ Limitations of Fiscal Policy
- Political constraints — tax increases are unpopular. Politicians may choose short-term popularity over long-term fiscal responsibility.
- Time lags — it takes time to identify the problem, pass legislation, and implement spending/tax changes. By the time the policy takes effect, conditions may have changed.
- Crowding out.
- Rising national debt — persistent deficits accumulate into debt. High debt → large interest payments → less money for public services (opportunity cost).
- Inefficiency — government spending may be less productive than private spending (bureaucracy, poor allocation).
- Inflationary risk — expansionary fiscal policy near full employment → demand-pull inflation.
Strengths of fiscal policy
- Can target specific sectors or regions (unlike monetary policy).
- Effective when monetary policy hits the zero lower bound (liquidity trap).
- Automatic stabilisers smooth the cycle without any decision lag.
- Can address inequality directly through progressive taxation and transfer payments.