Question

Many economists are worried that a high level of budget deficits may lead to inflationary monetary policies in the future. Could these budget deficits have an effect on the current rate of inflation?

Short answer

Yes, if these actions are fully expected, they may cause a short-term aggregate supply shift.

Step-by-step solution

Content Introduction

Inflation, or the constant rise in price levels, is one of the key threats of a budget deficit. A budget deficit in the United States can prompt the Federal Reserve to pump more money into the economy, feeding inflation

Content Explanation

Budget deficit is the difference between government receipts (mainly from taxes) and spending. There is a deficit when spending exceeds revenue. A surplus exists when revenue exceeds expenditure. When the budget deficit grows due to an increase in government spending or a decrease in government revenue, the Treasury must issue more bonds. This lowers bond prices and raises interest rates.