Q. 275.0( 1 Vote )

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Answer :

The term fiscal deficit is the difference between the government’s total expenditure and its total receipts (excluding borrowing). Fiscal deficits are not an important factor for inflation, but even then it is regarded as inflationary. When the government expenditure rises and tax reduces, in this situation the government faces a deficit. When there is an increase in the expenditure it will lead to an increase in the aggregate demand of the economy. However, the firms might not be in condition to meet the immediate rise in demands, this will simultaneously lead to forcing the price to rise. Hence, fiscal deficits are inflationary in this sense. The major reasons for fiscal deficit causing inflation in the economy are:

• The increase in expenditure will lead to an increase in aggregate demand and increase the price of the goods in the economy. This is because when the aggregate demand will increase the purchasing power of the economy which will simultaneously increase the prices.

• The expenditure in the economy will increase the money flow in the economy. This will increase the investment through government expenditure

It may not be the same in the case of the underdeveloped countries. In the underdeveloped countries the resources may be underutilized and not efficiently utilized. The expenditure in the correct way may lead to prosper in the economy without inflation through the fiscal deficit. If the resources are underutilized (due to insufficient demand) and output is below full employment level, then with the increase in government expenditure, more factor resources will be employed to provide to the increasing demand without exerting much pressure on price to rise. In these circumstances, a high fiscal deficit is accompanied by high demand, greater output level and lesser inflationary situation.

Hence, whether the fiscal deficits are inflationary or not depends on how close is the original output level to the full employment level and also the nature of the economy.

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