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Question
A large amount of fiscal deficit proves to be counter productive. Give any two reasons in support of this statement.
Solution
A large fiscal deficit occurs when the government's spending exceeds its revenues. This can be counter productive for two reasons:
- Increased Borrowing and Interest Rates: Governments typically borrow money to cover fiscal deficits, which can cause interest rates to rise. Investors face higher borrowing costs as interest rates rise. This results in a crowding-out effect that stifles economic growth as private sector spending falls in reaction to increasing borrowing costs.
- Future Tax Burden and Inflation: To repay debt, the government may need to raise taxes in the future, placing a burden on future generations. If the government chooses to finance the deficit by printing additional money, it may cause inflation, impeding future growth.
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