In the same way an economy can absorb only a certain amount of additional money without feeding inflation, but an excessive reliance on this source of financing a deficit would he pro- inflationary. The real purchasing power of money balances declines.
And the same happens with real rate of interest also. The burden of outstanding government debt declines and an increase in nominal interest rate seldom compensates for it. Another ill-effect of inflation caused by deficit spending is its impact on income distribution which shifts in favour of non-fixed residuals like profits.
We Will Write a Custom Essay Specifically
For You For Only $13.90/page!
Current thinking supports the thesis that inflation is mainly caused by deficit spending and can be cured only through budgetary reforms. Also deficit spending is a self feeding process. With price rise government expenditure rises faster than its revenue and the government is forced to resort to bigger deficits. Deficits cannot be sustained on a prolonged basis without damaging the economy. We have already noted some of these damaging effects like inflation, growing inequalities, and so on.