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Why is deficit financing considered a risky method of capital formation?
- a)It can lead to overproduction of consumer goods
- b)It can result in decreased inflationary pressures
- c)It may lead to excessive government borrowing
- d)It can trigger inflationary pressures in the economy
Correct answer is option 'D'. Can you explain this answer?
Verified Answer
Why is deficit financing considered a risky method of capital formatio...
Deficit financing can be risky because if not carefully managed, it can lead to inflationary pressures in the economy. When the government injects additional money into circulation without a corresponding increase in production, it can cause prices to rise, leading to inflation.
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Why is deficit financing considered a risky method of capital formatio...
Understanding Deficit Financing
Deficit financing refers to the practice of funding government spending by borrowing, rather than through current revenues. While it can stimulate economic growth, it is often considered risky due to its potential consequences.
Inflationary Pressures
Deficit financing can trigger inflation for several reasons:
- Increased Money Supply: When a government borrows money, it often leads to an increase in the money supply. More money in circulation can reduce the value of currency, resulting in higher prices for goods and services.
- Demand-Pull Inflation: By financing deficits, the government may increase overall demand in the economy. If this demand exceeds the economy's ability to produce goods and services, it can lead to demand-pull inflation, where prices rise as consumers compete for limited supplies.
- Expectations of Inflation: If businesses and consumers anticipate that deficit financing will lead to inflation, they may adjust their behavior accordingly. For example, businesses might raise prices preemptively, and consumers may rush to make purchases, further driving up demand and prices.
Long-term Economic Impact
While short-term deficit financing might boost economic activity, the long-term ramifications can be detrimental:
- Debt Servicing: Excessive borrowing can lead to a substantial debt burden. Servicing this debt may require higher taxes or reduced public spending in the future, which can stifle economic growth.
- Loss of Investor Confidence: If investors believe that a government's deficit financing is unsustainable, it may lead to decreased investment and higher interest rates, compounding the inflationary issue.
In conclusion, while deficit financing can be a tool for stimulating the economy, its potential to trigger inflationary pressures makes it a risky method of capital formation.
Deficit financing refers to the practice of funding government spending by borrowing, rather than through current revenues. While it can stimulate economic growth, it is often considered risky due to its potential consequences.
Inflationary Pressures
Deficit financing can trigger inflation for several reasons:
- Increased Money Supply: When a government borrows money, it often leads to an increase in the money supply. More money in circulation can reduce the value of currency, resulting in higher prices for goods and services.
- Demand-Pull Inflation: By financing deficits, the government may increase overall demand in the economy. If this demand exceeds the economy's ability to produce goods and services, it can lead to demand-pull inflation, where prices rise as consumers compete for limited supplies.
- Expectations of Inflation: If businesses and consumers anticipate that deficit financing will lead to inflation, they may adjust their behavior accordingly. For example, businesses might raise prices preemptively, and consumers may rush to make purchases, further driving up demand and prices.
Long-term Economic Impact
While short-term deficit financing might boost economic activity, the long-term ramifications can be detrimental:
- Debt Servicing: Excessive borrowing can lead to a substantial debt burden. Servicing this debt may require higher taxes or reduced public spending in the future, which can stifle economic growth.
- Loss of Investor Confidence: If investors believe that a government's deficit financing is unsustainable, it may lead to decreased investment and higher interest rates, compounding the inflationary issue.
In conclusion, while deficit financing can be a tool for stimulating the economy, its potential to trigger inflationary pressures makes it a risky method of capital formation.
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Why is deficit financing considered a risky method of capital formation?a)It can lead to overproduction of consumer goodsb)It can result in decreased inflationary pressuresc)It may lead to excessive government borrowingd)It can trigger inflationary pressures in the economyCorrect answer is option 'D'. Can you explain this answer?
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Why is deficit financing considered a risky method of capital formation?a)It can lead to overproduction of consumer goodsb)It can result in decreased inflationary pressuresc)It may lead to excessive government borrowingd)It can trigger inflationary pressures in the economyCorrect answer is option 'D'. Can you explain this answer? for B Com 2025 is part of B Com preparation. The Question and answers have been prepared according to the B Com exam syllabus. Information about Why is deficit financing considered a risky method of capital formation?a)It can lead to overproduction of consumer goodsb)It can result in decreased inflationary pressuresc)It may lead to excessive government borrowingd)It can trigger inflationary pressures in the economyCorrect answer is option 'D'. Can you explain this answer? covers all topics & solutions for B Com 2025 Exam. Find important definitions, questions, meanings, examples, exercises and tests below for Why is deficit financing considered a risky method of capital formation?a)It can lead to overproduction of consumer goodsb)It can result in decreased inflationary pressuresc)It may lead to excessive government borrowingd)It can trigger inflationary pressures in the economyCorrect answer is option 'D'. Can you explain this answer?.
Why is deficit financing considered a risky method of capital formation?a)It can lead to overproduction of consumer goodsb)It can result in decreased inflationary pressuresc)It may lead to excessive government borrowingd)It can trigger inflationary pressures in the economyCorrect answer is option 'D'. Can you explain this answer? for B Com 2025 is part of B Com preparation. The Question and answers have been prepared according to the B Com exam syllabus. Information about Why is deficit financing considered a risky method of capital formation?a)It can lead to overproduction of consumer goodsb)It can result in decreased inflationary pressuresc)It may lead to excessive government borrowingd)It can trigger inflationary pressures in the economyCorrect answer is option 'D'. Can you explain this answer? covers all topics & solutions for B Com 2025 Exam. Find important definitions, questions, meanings, examples, exercises and tests below for Why is deficit financing considered a risky method of capital formation?a)It can lead to overproduction of consumer goodsb)It can result in decreased inflationary pressuresc)It may lead to excessive government borrowingd)It can trigger inflationary pressures in the economyCorrect answer is option 'D'. Can you explain this answer?.
Solutions for Why is deficit financing considered a risky method of capital formation?a)It can lead to overproduction of consumer goodsb)It can result in decreased inflationary pressuresc)It may lead to excessive government borrowingd)It can trigger inflationary pressures in the economyCorrect answer is option 'D'. Can you explain this answer? in English & in Hindi are available as part of our courses for B Com.
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