Are fiscal deficits inflationary?
Fiscal deficits are often criticised for being inflationary, but this is not always the case. When the government increases spending or cuts taxes, aggregate demand increases. If firms are unable to produce higher quantities at the ongoing prices to meet this demand, prices will rise.
However, the outcome depends on the state of the economy. If there are unutilised resources, output is held back due to a lack of demand. In such a scenario, a high fiscal deficit is accompanied by higher demand and greater output.
Therefore, a fiscal deficit need not be inflationary if the economy has unutilised resources. It becomes inflationary only when supply cannot keep pace with the increased demand.
Explanation
The answer is derived from the 'Other Perspectives on Deficits and Debt' section of the provided context. It explains the inflationary argument (demand increases but supply cannot, leading to price rise) and the counter-argument (if unutilised resources exist, output increases instead of prices).