Question

Why may a budget deficit be considered undesirable?

Answer 1

A budget deficit is considered undesirable at a time when the economy is functioning at the potential level.

At the potential output, the economy is working at the full output and full employment level. A deficit or expansionary government budget will increase the income of the people and at a higher income, the demand will increase. As the economy has already reached the potential output the output can't be increased further and the new increased demand will cause inflation in the economy.

Apart from this, government budget deficit leads to crowding out of private investment. It increases the interest rates in the economy and at a higher interest rate, the private investment falls.