Question

“Fiscal deficit is necessarily inflationary in nature.” Do you agree? Support your answer with valid reasons.

Hint:

Fiscal deficit becomes inflationary mainly when it increases money supply without a corresponding increase in production.

Answer 1

Step 1: Meaning of Fiscal Deficit.
Fiscal deficit refers to the excess of total government expenditure over its total revenue (excluding borrowings) in a financial year. It indicates the amount of money the government needs to borrow to meet its expenses.
Step 2: Inflationary Nature of Fiscal Deficit.
Fiscal deficit can be inflationary when the government finances the deficit by borrowing from the central bank. In such cases, new currency is created, increasing the money supply in the economy.
Step 3: Increase in Aggregate Demand.
Higher government spending increases aggregate demand in the economy. If the production of goods and services does not increase at the same pace, the excess demand may lead to rising prices.
Step 4: Situations when Fiscal Deficit may not be Inflationary.
Fiscal deficit is not always inflationary. If the borrowed funds are used for productive investments such as infrastructure, education, and technology, it can increase production capacity and economic growth without causing inflation.
Step 5: Conclusion.
Therefore, fiscal deficit is not necessarily inflationary. Its impact depends on how the borrowed funds are utilized and the prevailing economic conditions.