National Debt

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21 Aug, 2024

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Table Of Contents

What is National Debt?

The national debt (or government or public debt) is defined as the total debt accumulated by the government over a period of time. It marks the money being borrowed to meet the budget deficits that occur from time to time. Increased levels of national debt may have far-reaching implications on the economic growth and stability of a country.

The national debt increases with the increasing budget deficit of an economy and decreases when a budget surplus is recorded. It is often measured as a percentage of an economy’s annual Gross Domestic Product (GDP). This debt-to-GDP ratio indicates the ability of a country to settle its debts. A low ratio indicates an economy generates more output and income to pay off its debts. Thus, the lower the ratio, the better it is and vice-versa.

National Debt Definition

The national debt is the total debt obligation of the federal government.
It results from excessive spending of the government over and above its revenue.
It is measured as a percentage of a country’s gross domestic product, referred to as the debt-to-GDP ratio.
A lower debt-to-GDP ratio is desirable as it indicates lower default risk.
Rising national debt reduces public and private investments, decreases opportunities, and increases the risk of financial crisis in any economy.

Understanding National Debt

The national debt is the money that successive governments borrow to ensure their economies remain financially balanced. However, in this attempt, the nations end up accumulating debt, which they owe to their lenders.

The concept of government debt is often confused with the term budget deficit. Also referred to as fiscal deficit, the latter marks the increase in the government’s expenditure, which is more than the revenue it generates through taxes. Budget deficit of each year increases the government debt balance.

Government debt may be classified as internal or external debt. While internal debt is the amount the country owns to the creditors within the country, external debt is the sum payable to foreign lenders.

Government raises internal debt mostly through the issue of bonds to the public and loans from commercial banks. At the same time, it procures external debt from other nations or international institutions such as the World Bank.

The Bank for International Settlements (BIS) frames and administers the rules and takes care of the settlement of the public debt. In some countries, a national debt clock keeps calculating and updating the amount that respective nations owe to their creditors.

As mentioned earlier, government debt is considered in relation to the total economic output or GDP. Thus, large economies can have more obligations as compared to small economies as they have greater resources to discharge the debt.

Unsustainable levels of public debt may negatively impact the economy and call for government policy measures. For example, Greece’s debt crisis led its government to adopt austerity measures to revive its economy.

National Debt of the US

The United States government debt is more than $30.37 trillion as of April 2022. It comes in two forms:

Debt held by the public is the amount the federal government owes to Treasury investors. The investors can be anyone from national and international investors to governments operating overseas.
Intragovernmental debt is the sum the federal government borrows from other government departments. This fund includes pensions and other financial schemes running in the nation.

The budget deficit also adds to the rising public debt. The deficit is the difference between government expenditure (which is more) and its revenue (which is less). Government adds the budget deficit to the existing national debt at the end of every fiscal year.

National Debt of China

The government debt of China is over $5 trillion (equals over 40 trillion Yuan) as of December 2021. The Chinese government borrows funds in the form of federal government bonds and municipal bonds. The public debt figures do not include monetary assistance that does not involve bonds or bills, like pension obligations, etc.

The Ministry of Finance in China attempts to raise funds for the national government and supervise debt instruments as and when issued by local governments. On the other hand, the Central Economic and Financial Commission, a separate committee, looks after the economic activities and public finances administered in the nation.

In April 2018, South China Morning News cited an estimation made by the nation’s National Institute of Finance and Development, which gave an account of China's debts. As per the report, the local government owed hidden debts that increased the national debt amount, overburdening the central government.

In China, the provinces and local governments enjoy a significant level of autonomy, which makes them extend their financing. As a result, the local governments raise their own funds by direct issuance bonds.

National Debt of Canada

The government debt of Canada is over $1.1 trillion as of March 2022. The Department of Finance Canada issues public debt in local currency. The currency conversion is based on the Federal Reserve Board period-end market exchange rate.

If closely observed, Canada’s federal debt increased steadily between 5% and 10% every year until 1975. Post the period, the range exploded and started growing at a much faster rate, accounting for an average of over 20% per year.

How National Debt Affects Economy?

The rising public debt causes fiscal imbalance, adversely affecting the economies. Public debts arise when government spending exceeds its revenue. However, government spending is essential as it provides a positive platform for an economy to grow and prosper.

The policymakers work on building a stronger foundation for an economy through public expenditure. This helps the public to get greater access to capital, better resources for future private and public investments, etc.

However, the increasing public debt affects the policymaking process, impacting the economy. Some of the significant effects of rising government debt on the economy are as follows:

#1 - Reduced investments

When the public debt increases, the government's spending on interest costs rises significantly. As a result, a large proportion of government funds go in for interest payments, which affects the necessary public investment in other areas that are important for the overall economic growth of any nation.

The government looks for funds in the capital markets to get rid of the government debt, which leads to an increase in interest rates. As a result, the start-ups have to pay a higher amount for capital and other resources. This makes it difficult for the new business players to sustain themselves. Hence, they put the private investments on hold.

#2 - Diminishing opportunities

The crowding-out effect directly or indirectly affects the availability of opportunities in an economy. When private investments reduce, businesses cut costs. As a result, workers have nowhere to work and earn their living. This adversely impacts the economic condition of everyone from the micro to the macro level.

#3 - Increased risk and fiscal crisis

With reduced investment, the investors lose confidence in the fiscal policies framed to keep the economy intact. This loss of confidence raises the interest rates on finances issued and Treasury rates, making it difficult for individuals or entities to obtain loans even if it’s necessary. This, in turn, leads to turmoil in the overall economic system, igniting inflation and creating fiscal imbalance.

Frequently Asked Questions (FAQs)

What is national debt?

The national debt is defined as the total liabilities of the central government over a period of time. It is measured as a percentage of an economy’s annual gross domestic product (GDP). It is the money that successive governments borrow to meet their budget deficits and grow the economy.

Does national debt matter?

The rising national debt causes fiscal imbalance, negatively impacting the economies. When the public debt increases in proportion to its gross domestic product, the possibility of default rises. Therefore, the government increases interest rates on bonds but curtails public expenditure.
Also, the general rise in interest rates increases the cost of debt of the companies. Therefore, the companies raise the prices of goods and services causing inflation. Thus, reduction in public expenditure and inflation adversely affect the economy in the long run.

How are budget deficit and national debt related?

The budget or fiscal deficit marks the increase in the government’s expenditure, which is more than the revenue it generates through taxes. The budget deficit gets added to the existing national debt amount at the end of every fiscal year. The national debt increases with the increasing budget deficit of an economy and decreases when there is a budget surplus.