Question

What is the difference between a structural deficit and a cyclical deficit?

Short answer

A structural deficit is a budget deficit that exists across the business cycle due to a persistent imbalance between government spending and revenues. A cyclical deficit, on the other hand, is temporary and is caused by an economic downturn, it rises during periods of slow economic activity and falls when the economy is booming.

Step-by-step solution

Define Structural Deficit

Structural deficit refers to the portion of the budget deficit that remains across the business cycle, because the general level of government spending exceeds total revenues, regardless of the strength or weakness of the economy. In essence, this type of deficit would exist even when the economy is operating at its full capacity.

Define Cyclical Deficit

Cyclical deficit refers to the part of the budget deficit which is caused by an economic downturn. It rises during periods of slow economic activity and falls when the economy is booming. Thus, cyclical deficits are temporary fluctuations in a nation's deficit caused by economic changes.

Distinguish Between Structural and Cyclical Deficit

The main difference between these two types of deficits lies in their cause. While a structural deficit is caused by a fundamental imbalance between government expenditure and revenue, a cyclical deficit is driven by the changes in economic activity. Structural deficits can only be corrected through fiscal policy adjustments, such as increasing revenues or reducing spending. Conversely, cyclical deficits typically correct themselves over time as the economy goes through its normal business cycle.