Question

Which of the following statements are correct

Statement 1: Fiscal deficits are not necessarily inflationary; though, they are generally regarded as inflationary.

Statement 2: When the government expenditure increases and tax reduces, there is a government deficit and there will be a corresponding increase in the aggregate demand.

Options

• Fiscal deficits are not necessarily inflationary; though, they are generally regarded as inflationary.

• When the government expenditure increases and tax reduces, there is a government deficit and there will be a corresponding increase in the aggregate demand.

• Both Fiscal deficits are not necessarily inflationary; though they are generally regarded as inflationary and when the government expenditure increases and tax reduces, there is a government deficit and there will be a corresponding increase in the aggregate demand.

• None of the above

Answer 1

Both Fiscal deficits are not necessarily inflationary; though they are generally regarded as inflationary and when the government expenditure increases and tax reduces, there is a government deficit and there will be a corresponding increase in the aggregate demand.

Explanation:

Fiscal deficits are not always inflationary; yet, they are commonly considered as such. When government spending rises while taxes fall, there is a government deficit and a commensurate rise in aggregate demand. However, the enterprises may be unable to meet the increased demand, causing the price to rise. In this sense, budget deficits are inflationary.

However, if resources are underutilised (because of insufficient demand) and output is below full employment, an increase in government expenditure will cause more factor resources to be engaged to meet the growing demand without putting any pressure on prices to rise. In this case, a large budget deficit is accompanied by a high level of demand, higher output, and a lower level of inflation. As a result, whether budget deficits are inflationary or not is determined by the original output level's proximity to full employment.