Question

Explain the role of the government budget infighting inflationary and deflationary tendencies.

Answer 1

Role of the government budget infighting deflationary and inflationary situations:
During the deflationary situation, the government can take the following steps:

i. Deficit financing or borrowing by the government from the Central Bank against treasury bills. The Central Bank purchases 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 rise in the general price level, while other things remain constant.
ii. The tax burden is decreased to adjust the deficient demand and thereby the purchasing power of the people will increase.
iii. Increase in public expenditure on infrastructural development improves the production efficiency of 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 public expenditure.

During the inflationary situation, the government can take fiscal measures to reduce excess demand as follows:
i. Increase in taxes: The government levies new taxes and enhances the rate of prevailing ones. It will reduce the disposable income of people, and therefore, the aggregate demand is reduced.

ii. Surplus budget policy: The government’s expenditure should remain less than its income to control the excess demand. 
iii. A decrease in public expenditure leads to a fall in aggregate demand. This, in turn, reduces the price level of goods in the market