Consider the following statements about government deficits:
(A) Deficits are criticised as inflationary because aggregate demand increases when the government raises spending or cuts taxes.
(B) When there are unutilised resources, a high fiscal deficit need not be inflationary.
(C) Government bonds compete with corporate bonds for the available funds, so some private borrowers may be crowded out.
(D) The economy’s flow of savings stays fixed even when government deficits succeed in raising production.
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → (A), (B) and (C) only
Deficits are judged in three ways here: their effect on prices, on output when resources are spare, and on private investment.
(A) Deficits are criticised as inflationary because aggregate demand increases when the government raises spending or cuts taxes. — Correct. If firms cannot produce more at current prices, the extra demand pushes prices up.
(B) When there are unutilised resources, a high fiscal deficit need not be inflationary. — Correct. With spare resources, higher demand brings more output instead of higher prices.
(C) Government bonds compete with corporate bonds for the available funds, so some private borrowers may be crowded out. — Correct. Savers who buy government bonds leave less for private firms. This is crowding out.
(D) The economy’s flow of savings stays fixed even when government deficits succeed in raising production. — Incorrect. Savings are not fixed. If deficits raise production, there is more income and more saving.
NCERT (2026-27): “Other Perspectives on Deficits and Debt: One of the main criticisms of deficits is that they are inflationary. This is because when government increases spending or cuts taxes, aggregate demand increases. Firms may not be able to produce higher quantities that are being demanded at the ongoing prices. Prices will, therefore, have to rise. However, if there are unutilised resources, output is held back by lack of demand. A high fiscal deficit is accompanied by higher demand and greater output and, therefore, need not be inflationary. It has been argued that there is a decrease in investment due to a reduction in the amount of savings available to the private sector. This is because if the government decides to borrow from private citizens by issuing bonds to finance its deficits, these bonds will compete with corporate bonds and other financial instruments for the available supply of funds. If some private savers decide to buy bonds, the funds remaining to be invested in private hands will be smaller. Thus, some private borrowers will get ‘crowded out’ of the financial markets as the government claims an increasing share of the economy’s total savings. However, one must note that the economy’s flow of savings is not really fixed unless we assume that income cannot be augmented. If government deficits succeed in their goal of raising production, there will be more income and, therefore, more saving. …” |