Is the deficit that important?

I often hear on the radio or read in the newspaper that the government is aiming to reduce the national debt and this is the reason for the strict fiscal policies they are implementing. That is an incorrect statement. The government cannot be looking at reducing the national debt, since the UK has such a high deficit at the moment.

The deficit is the difference between how much the government spends and how much it collects on a yearly basis. Our national debt however, is the total amount we owe. So the deficit in fact adds to the amount of debt, we as a nation owe. The difference between the deficit and the debt is especially important because when politicians talk about reducing the deficit, all that really means is that our debt isn’t growing as fast. It does not mean we’re actually getting out of debt.

Reducing the deficit is such a major objective as it is growing at a faster rate than the economy. This means a rising debt to GDP ratio, which in the future could provide the country with a debt that is out of control. Obviously this presents a problem, as shown by the way Greece has been affected by its huge debt, which is resulting in an economic collapse.

The deficit has already been greatly reduced by this government, as it has fallen to 8.3% of GDP, but more needs to be done to reach the 3% figure. Reducing the deficit flags up a certain policy conflict, as the reduction in government spending also makes it much harder for the economy to recover and overcome this period of stagnation. I personally feel that the deficit is a slightly more important focus, because if it continued to stay at such high levels, the effects on the economy would be much more dramatic and damaging than if we stay in a recession for longer. 

UK interest rates and economic growth

Why have constant low interest rates not had the desired effect of increasing GDP like economic theory would dictate?

Interest rates have been at a record low of 0.5% for more than three years now an outcome the monetary policy committee had in mind was an increase in GDP. This increase in GDP would stem from the theory that comparatively low interest rates should increase consumer spending and also investment. These increases contribute to an overall increase in demand in the economy, which in an ideal world would lead to no/minimum inflation while decreasing unemployment as supply tries to keep up with demand.


The increase in consumer spending and investment comes from the idea that such a low interest rate gives people and firms’ very little incentive to save, so therefore spend more. The interest rate means that consumers get very little interest on their savings in banks and it also means for firms that it is 'cheaper' to borrow money from banks to finance ventures such as buying new machinery as they pay less interest on their loans.


This seems like justifiable plan, but the theory is under the constraints of ceteris paribus, meaning that it will work with all other things staying equal, so no other interferences on the economy. This highlights a limitation that can be seen in many economic theories and is the reason why economists cannot predict the future of an economy, which does not live up to the expectation of many people.

The interference that is stopping this seemingly painless answer to our problems are the fiscal policies also being undertaken. The restrictive fiscal policies are a way of reducing the national deficit (not national debt as the media often publicises). The government are rightly trying to reduce this deficit to a reasonable level, which allows the national debt to become manageable.

Austerity reduces government spending in the economy, which directly reduces the demand in an economy. It also leads to a potential reduction in consumer spending as benefits or public sector wages are reduced. This reduction in demand and other factors such as low confidence counteract the increase in demand that should be seen due to the low interest rates. In addition since interest rates are low but have not really increased demand in the economy to a sufficient level, they will have to stay at this record low for the foreseeable future, while different monetary devices are used such as quantitative easing.