Question

Explain the role of government budget in bringing stability in the economy.

Answer 1

Role of government budget in fighting deflationary and inflationary and situation:-

During the deflationary situation, the government can take the following steps:-

1. Deficit financing means borrowing by the government from the Central Bank against treasury bills. The Central Bank purchase treasury bills for cash and the government uses these funds to finance the deficit. It increases the flow of money circulation in the economy. Therefore, there is an increase in demand for goods which leads to a raise in the general price level, while other things remaining constant.

2. Tax burden is decreased to adjust deficient demand and thereby purchasing power of the people will increase.

3. Increase in public expenditure on infrastructural development improves the production efficiency of the industries and increases employment opportunities and it encourages private enterprises by initialising state-owned financial and banking institutions to provide cheap credits. The aggregate demand increases with an increase in the public expenditure.

During inflationary situation, the government can take fiscal measures to reduce excess demand as follows:-

1. Increase in taxes:- Government levies new taxes and enhances the rate of prevailing ones. It will reduce the disposable income of the people, and therefore, the aggregate demand is reduced.

2. Surplus budget policy:- Government’s expenditure should remain less than its income to control the excess demand.

3. Decrease in public expenditure leads to a fall in aggregate demand. This in turn reduces the price level of goods in the market.