How Fiscal Policy control Inflation

In the situation of inflation there is a high price rise in the economy, this is due to increase in Aggregate Demand (AD). When there is an increase in AD beyond the full employment level, output remain constant since output cannot be increased as there is full employment, all resources are fully utilized, this leads to an increase the cost of production of existing factors of production and price rises. More and more rise in prices leads to a situation of inflation due to the situation of excess demand .

Fiscal Policy

Fiscal policy is the revenue and expenditure policy of the government. It is also called as the budgetary policy of the government. Through its revenue and expenditure policy, situation of  ---

inflation ( excess demand ) and deflation ( deficient demand ) 

is checked and controlled by varying the size and composition of revenue as well as of expenditure. Fiscal policy leads to the growth and stability of the economy. Fiscal policy is the policy of the government which includes components like taxation, public expenditure and public borrowing. Following are the principal instruments of fiscal policy which, when used in a proper combination to achieve the best possible results in terms of the desired economic objectives like.

Maintaining economic stability

High employment

And, accelerating economic growth

How Fiscal Policy Correct deficient demand situation

We have seen that deficient demand leads to deflation in the economy, 

so it’s  necessary to correct this deficient demand situation. Here, we will see how Fiscal Policy of the government will control the situation of deficient demand.

Fiscal Policy: 

Fiscal policy can be used effectively to raise demand in the economy to correct the situation of deficient demand. Fiscal policy is the policy of the government which includes components like taxation, public expenditure and public borrowing.

Following are the principal components of fiscal policy. Along with each component, we are describing the way it is used to correct situations of deficient demand.

a) Government expenditure:

It is the principal instrument of fiscal policy. The government of a country incurs various types of expenditure, mainly:

i) Expenditure on public work programmes like construction of dams, bridges, roads etc.

ii) Expenditure on education and welfare programmes.

iii) Expenditure on defence and law and order.

iv) Expenditure on subsidies to the producer for encouraging production. 

In the situation of deficient demand, the government should increase its expenditure (as said above).

Increasing government expenditure means increasing government spending. We have read in investment multiplier mechanism that expenditure leads income generation.

Expenditure by one person becomes the income of another person.

How Fiscal Policy Correct Excess demand situation

We have seen that excess demand leads to inflation in the economy, so it’s necessary to correct this excess demand situation.Here, we will see how Fiscal Policy of the government will control the situation of excess demand.

Fiscal Policy:

Fiscal policy can be used effectively to reduce the excess demand. Fiscal policy is the policy of the government which includes components like taxation, public expenditure and public borrowing.

Following are the principal components of fiscal policy. Along with each component, we are describing the way it is used to correct situations of excess demand.

a) Government expenditure:

It is the principal instrument of fiscal policy. The government of a country incurs various types of expenditure, mainly:

i) Expenditure on public work programmes like construction of dams, bridges, roads etc.

ii) Expenditure on education and welfare programmes.

iii) Expenditure on defence and law and order.

iv) Expenditure on subsidies to the producer for encouraging production.

In the situation of excess demand, the government should reduce its expenditure, mainly unproductive expenditure like defence and administrative expenditure, interest payments etc.