By Peter Dwyer
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Budget deficit guide

This article is over 12 years, 2 months old
What does the deficit mean?
Issue 2196

What does the deficit mean?

The main source of government income is taxation of workers and businesses.

If a government spends more money than it gets through taxation, it has what’s called a budget deficit.

After the budget, chancellor Alistair Darling forecast that the deficit for this year is £167 billion.

The government makes up the difference between what it expects to get in income from taxes and what it wants to spend by issuing (selling) government bonds (often in the form of what are called gilts).

They are mainly sold to financial institutions in the City of London—insurance companies, pension fund managers and other big investors—who can be based in the UK or abroad.

These bonds guarantee a certain amount of interest.

At the moment, when governments are competing to attract funds, the government has to offer higher interest rates, and has to pay more each year in debt-interest payments to the people who bought the bonds.

As the government budget deficit increases, so must the amount of money the government puts aside to pay the interest.

The sum total of all these bonds is called the public debt.

If the investors are not happy with government policies they can refuse to buy more bonds—an “investment strike”.

When does it have to be paid back?

There are no laws that say when the deficit has to be paid back.

The levels of debt becomes a problem when investors (like those who buy government bonds) worry that the government will be unable to pay them back.

To keep the free market investors happy the government is being pressured by the European Union (EU) and other institutional investors to pay it back sooner rather than later.

EU rules say government deficits must be below 3 percent of Gross Domestic Product (GDP).

In December last year, the EU commission said Britain should reach this target by 2014-15.

As the deficit is expected to hit 12.6 percent of GDP this year the government’s plans announced in the budget would see the deficit reduced over four years to 4 percent by 2014-15.

Whoever wins the election, workers will have to fight to stop the government taking draconian measures just to avoid a “strike” by the buyers of bonds.

Dr Peter Dwyer teaches economics at Ruskin College, Oxford. »

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