Unit 3 · Level 2 · Government debt & fiscal policy
Deficits & debt
Picture government finances as a bathtub. The DEFICIT is the tap: how much borrowing pours in this year. The DEBT is the water level: everything ever borrowed and not repaid. News headlines constantly confuse the two. 'The deficit fell!' just means the tap is running slower. The tub is still filling.
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What you get asked
What's the difference between the deficit and the debt?
Deficit is a FLOW (per year), debt is a STOCK (the pile). A country can shrink its deficit every year and still watch its debt grow: smaller tap, rising water.
A country owes €1,000bn and runs a €50bn deficit every year. Ignoring interest, what is its debt after 4 years, in billions of euros?
Each year's deficit stacks onto the pile: 1,000 + 4 × 50 = €1,200bn. That's the whole flows-vs-stocks idea in one sum: deficits are the bricks, debt is the wall.
Economists usually compare a country's debt to its ___ , because that measures the economy's ability to carry it.
€2 trillion of debt is crushing for a small economy and manageable for a giant one. Like a mortgage, what matters is the loan relative to your income. Hence debt-to-GDP.
Match each fiscal term to what it is
Master this vocabulary and half of all budget headlines instantly make sense. Flow vs stock is the same distinction as your salary vs your net worth.
Why can a rich, trusted country carry far more debt than a fragile one?
Japan carries debt above 200% of GDP because lenders trust repayment and keep rolling it over cheaply. Debt capacity is really borrowed trust, and as we'll see next lesson, trust can vanish in a week. 🐜
The rest of this unit
Deficits, bond markets, and the day investors say no.