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Are fiscal deficits inflationary?
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Yes, if fiscal deficits are financed by issuing new currency, inflation will rise. It could be worse if the new currency is used to finance the government's current consumption expenditure. When government spending increases while taxation decreases, there is a government deficit, and aggregate demand rises as a result. Fiscal deficits are thus inflationary in this sense. If new funds are used for infrastructure or other capital projects, the fiscal deficit will not cause inflation. In this case, a high fiscal deficit is accompanied by high demand, resulting in a higher output level and a lower inflationary situation.
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