Question

Explain the use of fiscal policy in controlling inflationary situation.

State two ways through which the fiscal policy can be used to control inflation.

Answer 1

Keynes has emphasized the need for fiscal policy in reducing inflation. In essence, an inflationary scenario arises when private expenditures on goods, investment, and consumption, as well as foreign expenditures, beyond the output of full employment. According to Keynes, full employment is a prerequisite for the onset of real inflation. But in reality, because of additional factors, supply constraints, and rigidities, inflationary pressures are felt even before full employment.

For checking such situations in the economy, the following fiscal measures can be adopted:

1. Control over Public Expenditure: To the greatest extent feasible, efforts should be made to reduce wasteful spending.
2. Increase in Taxes: The government should levy new taxes as another method of controlling inflation. It is possible to increase the old tax rate.
3. Increase of Public Borrowing: Public borrowing may be used to absorb the private sector’s purchasing power in order to cut down on private spending.
4. Delay in the Payment of Old Debts: The government should attempt to postpone the repayment of previous debts in order to control inflation.
5. Surplus Budget: The government ought to create a fiscal surplus. Demand and the level of prices will consequently decline.
6. Over-valuation of Money: It must be overvalued in order to reduce inflation. As a result, it will support a decrease in exports and a rise in imports.