Is deficit financing inflationary? Justify your answer. – InterviewSolution

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1.	Is deficit financing inflationary? Justify your answer.
Answer» When the process of deficit financing is undertaken, the supply of money increases. In fact, the supply of cash money increases. In India, for example, if the Govt, decides to issue new money, it will print one rupee notes and/or issue small coins. This increases the cash money supply. If the Government decides to borrow from the Reserve Bank of India (which is India’s central bank) it transfers its securities to the Reserve Bank. On the weight of securities, the Reserve Bank issues currency notes of Rs 2/- or higher denomination. This is how the Govt, gets the extra money. In both cases, the amount of cash money is the economy and, therefore, the total money supply (i.e. cash plus demand deposits in banks) increases. It means extra purchasing power in the hands of the general people. This may create excess demand conditions in the economy. So there will be upward pressure on the general price level.

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