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Practice each question, then open the answer or worked solution.
Explain the relation between government deficit and government debt.
A government, in order to adjust the government deficit, which is created due to borrowings by the government, seeks more borrowings; these borrowings create further debt for the government in the form of interest payments. Therefore, an increase in the deficit will lead to an increase in debt.
Does public debt impose a burden? Explain.
Public debt is referred to the amount of money that a government owes to banks, financial institutions and other sources of finance. It is known to impose a burden on the economy in the following ways:
1. Government may impose taxes or print new money to repay the existing debts. Such a situation will hamper the productivity of the nation.
2. A high level of debt creates a burden on future generations in the form of interest and taxes being levied on the younger generation, which will result in lower consumption and savings.
3. More investments are attracted by the government by raising the interest rates on bonds and securities. Therefore, citizens’ money is utilised by the government and hence less private investment.
4. Wealth of the nation is depleted when loans are repaid to foreign institutions and countries.
Are fiscal deficits inflationary?
A fiscal deficit will not always result in inflation. If a situation arises when government expenditure increases and tax reduction is seen, it will cause a deficit in the government, which leads to an increase in aggregate demand. Firms will not be able to meet the demand thus generated, which will result in a price increase. Therefore, fiscal deficits can become inflationary, but they will not be inflationary in the case when resources are less utilised due to insufficient demand and less output. Then, if the government is spending more also, more resources will be employed in order to meet the growing demand, and there will be no pressure on price rise. In such a situation, a high fiscal deficit, along with high demand and greater output, will not create an inflationary situation.
Discuss the issue of deficit reduction.
Government can reduce the budget deficit by the following methods:
1. Decreasing expenditure
2. Increasing Revenue
Decreasing Expenditure can be achieved by
a. More planned activities should be undertaken by the government to reduce expenditure.
b. Encouraging the private sector to contribute to some major capital projects will help reduce expenditure.
An increase in revenue can be obtained by
a. Raising taxes or introducing new taxes can contribute to an increase in revenue.
b. By selling stakes in PSU, the process called divestment can bring in more revenue.
NCERT Solution for Class 12 Economics Chapter 5 – Government Budget and Economy. This chapter explains, in brief, a manner about how the budget and employment are determined.
Chief concepts of this chapter –