Three kinds of red ink

America’s latest fiscal accounts contain a large shortfall and several opportunities for confusion. Treasury figures released on October 16th put the deficit for the fiscal year ended September 30th at about $2trn. The Congressional Budget Office’s preliminary assessment, published on October 8th, had reached much the same rounded total, equal to about 6.2% of GDP. Yet the deficit is only one measure of the government’s finances. It is neither the national debt nor the cost of servicing that debt.

The distinction matters whenever a proposal promises to “cut the debt” by reducing the deficit, or an interest figure is compared with spending on public services. Such comparisons can be informative. They can also combine different accounting concepts and produce an impressive number with very little meaning.

A flow and a stock

The deficit measures the gap between federal outlays and receipts over a period. If spending exceeds revenue, the government normally needs additional financing. Debt is the amount outstanding at a particular date. A smaller deficit generally means that debt accumulates more slowly; it does not, by itself, mean that the outstanding debt falls.

A simple fictional example makes the point. A borrower owing £1,000 who adds £100 this year and £50 next year has halved the annual addition while increasing the total owed. The example omits interest and other transactions deliberately. It isolates the mistake in describing any reduction in new borrowing as a reduction in the stock of debt.

Even in government accounts, the change in debt does not equal the budget deficit exactly. Treasury can increase or draw down its cash balance. Federal lending and other financial transactions can affect financing requirements differently from their recorded budget costs. CBO’s debt primer explains these adjustments. A comparison of daily debt readings with an annual deficit should therefore allow for more than a simple subtraction.

There is a further calendar trap. America’s federal fiscal year ends in September. Figures for a calendar year, a fiscal year and a trailing twelve-month period need not describe the same activity. The latest Treasury total is an account of a completed fiscal year. It should not be silently compared with a forecast covering a different window.

Who holds the IOU?

Gross federal debt includes securities held by the public and securities held by federal government accounts, including trust funds. Debt held by the public includes holdings outside those government accounts, among them those of the Federal Reserve. In this terminology, “public” does not mean only American individuals.

The distinction changes the economic question being asked. Publicly held debt is particularly useful for examining the government’s claim on financial markets. Intragovernmental securities record commitments between parts of the federal government. They matter for the programmes concerned, but cannot be treated as an additional loan from an outside investor when the government is viewed as a whole.

Neither measure is a complete inventory of every future obligation. Promised benefits depend on legislation and future circumstances; their treatment differs from that of an outstanding Treasury security. Adding estimates of future promises to current debt without explaining the assumptions does not create a more accurate daily debt counter.

The interest bill

Interest is a flow of expenditure associated with debt. Its size depends on the amount borrowed, the rates paid and the timing of refinancing. A rise in market yields does not instantly reprice every outstanding fixed-rate bond. The effect reaches the budget as new securities are issued and old ones mature, while other instruments respond differently.

Gross interest and net interest answer different questions. The government pays interest, but also receives it. Some interest payments go to federal accounts and are internal transactions. The net-interest category in the budget removes relevant receipts and offsets. Comparing a gross Treasury interest figure with a net spending category elsewhere can exaggerate the contrast.

The “primary” budget balance removes net interest from the total balance. It helps separate the government’s current non-interest spending and revenue choices from the financing cost of accumulated debt. A primary surplus would not necessarily produce an overall surplus if the interest bill were larger. Conversely, an overall deficit can worsen because interest costs rise even when the primary balance improves.

These distinctions explain why a fiscal adjustment takes time. A change in tax or spending policy can influence the primary balance sooner than it alters the entire debt stock. The stock then influences future interest payments. The feedback is real, but its speed depends on maturities, growth, rates and the policy itself.

Scale before slogans

Dollar totals need a denominator. A growing economy can support a larger nominal debt than a stagnant one, which is why analysts compare debt and deficits with gross domestic product. But the ratio is not a verdict by itself. Revenue capacity, the currency of borrowing and investor confidence also matter. No single threshold mechanically separates safety from crisis.

The October accounts establish that spending exceeded receipts by a substantial amount over the completed year. Assessing a remedy requires another step: specifying whether it changes annual borrowing, the debt path, interest costs or some combination, and over what period. A plan that narrows a deficit can be meaningful even while debt continues to rise. Calling that a debt reduction would still be wrong.