Inflationary effect of deficits
Topic: Government Budget, Fiscal Policy and FRBM · NCERT: Class 12, Ch 5 "Government Budget and the Economy"
Meaning
A fiscal deficit adds to aggregate demand (total spending in the economy). Whether this raises prices depends on whether output can grow to meet the extra demand. Near full capacity, output cannot expand much, so more demand mainly pushes up prices, which is inflation. With unutilised resources, such as idle workers and machines, the extra demand is met by producing more, so a high deficit need not be inflationary. The NCERT point is that the deficit is not always inflationary: the state of the economy decides.
Example
In a slump, a deficit that pays for roads and wages can put idle workers and machines back to work. Output rises and prices stay stable. The same deficit in a boom, when factories are fully busy, mainly pushes up prices.
Don't confuse with
- Monetised deficit: the part of the fiscal deficit financed by the RBI, measured as the rise in the RBI's net credit to the government. It creates new money. Inflation risk depends on capacity, not on the deficit figure alone.
Related concepts
- Public debt
- Burden of debt
- Intergenerational equity
- Ricardian equivalence
- Crowding out
- Crowding in
- Debt-to-GDP ratio
- Debt sustainability
- Interest rate-growth differential
- Twin deficit