Final answer:
A budget deficit adds to the national debt by requiring the government to borrow funds to cover the shortfall, whereas the national debt is the sum of all past deficits and surpluses. Continuous deficits increase the debt, while surpluses can help to reduce it.
Step-by-step explanation:
The relationship between a budget deficit and national debt is best understood when realizing that the deficit refers to the shortfall in a particular fiscal year, where expenditures exceed revenues, whereas the debt is the accumulation of all past deficits and surpluses. A budget deficit (option 1) directly adds to the national debt, as the government must borrow money to cover the gap between spending and income. Over time, recurring deficits continue to increase the debt. On the other hand, the national debt can indirectly affect future deficits, through interest payments on the debt that increase future expenditures.
Historically, the U.S. has run up significant debt in times of war, such as World War II, then gradually repaid it during peacetime. However, periods of large deficits, like those in the 1980s and early 1990s, cause a sharp rise in the debt-to-GDP ratio. Conversely, during times of budget surpluses, as seen from 1998 to 2001, this ratio can decline. The crucial takeaway is that the debt-to-GDP ratio is an important indicator of a nation's fiscal health and represents the scale of a nation's debt in relation to its economic output.