Question

Consider the following statements related to the effects of deficit financing:

A. Deficit financing decreases real wage rate in the economy.

B. It causes current account surplus.

C. It leads to appreciation of domestic currency.

D. It creates deflationary situation in the economy.

Which of the statements given above are correct?

1. A only
2. B and C only
3. A, C and D only
4. B, C and D only

Answer 1

Correct Answer: A only

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Explanation:

1. Statement A:

   • Deficit financing decreases real wage rate in the economy.
   • Correct:
     • Deficit financing can lead to inflationary pressures, reducing the purchasing power of wages (real wage rate). This is a common effect of increased money supply in the economy.

2. Statement B:

   • It causes current account surplus.
   • Incorrect:
     • Deficit financing often leads to a current account deficit as increased inflation reduces export competitiveness while increasing imports.

3. Statement C:

   • It leads to appreciation of domestic currency.
   • Incorrect:
     • Deficit financing generally causes depreciation of the domestic currency due to inflationary pressures and a higher fiscal deficit.

4. Statement D:

   • It creates deflationary situation in the economy.
   • Incorrect:
     • Deficit financing typically leads to an inflationary situation, not deflation, as it increases the money supply in the economy.

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Conclusion:

The correct statement is A only.