Which of the following statements about deficits and inflation is NOT correct?
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → When there are unutilised resources, a high fiscal deficit is accompanied by lower output.
With unutilised resources, output is held back by too little demand. A deficit raises demand, so output rises.
Option (1) If firms cannot produce the higher quantities demanded at the ongoing prices, prices will have to rise. — True. This is why deficits can be inflationary.
Option (2) Deficits are criticised as inflationary because aggregate demand rises when the government spends more or cuts taxes. — True. This is the main criticism of deficits.
Option (3) When there are unutilised resources, output is held back by a lack of demand. — True. Resources lie idle because demand is low.
Option (4) When there are unutilised resources, a high fiscal deficit is accompanied by lower output. — False. A high deficit then comes with greater output, so it need not be inflationary.
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. …” |