This is a good question – how can deficits, which increase aggregate demand, contribute to economic stagnation? The problem concerning stagnation arises not on the demand side of the economy, but rather on the supply side. If large government budget deficits are financed by heavy borrowing by government, in competition with business borrowing, the result can be depressed capital investment by business.
Business investment spending could be depressed for two reasons. First, the excess demand for the limited volume of savings could drive interest considered appropriate to borrow to buy them and repay the loan in the future.
Another reason for federal government borrowing is to finance budget deficits to combat recessions. Thus, the federal government’s responsibility for minimizing the effects of recessions sometimes requires it to go into debt. Historically, another major reason for government borrowing and increases in the National Debt has been the financing of wartime expenditures. For example, the Second World War added over $10,000,000,000 to Canada’s National Debt.
Each of the above is generally considered to be a legitimate reason for borrowing by the government. However, ordinary operating expenses of the government, such as its payroll, should be paid for by tax revenues. It is not considered to be good financial practice to borrow (or even worse, print) money to cover operating expenses, or to avoid a necessary increase in taxes for political reasons, any more than it is considered appropriate for households to go into debt to pay their telephone or food bills.
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