Explain the fiscal measures to control inflation.

Asked by Topperlearning User | 22nd Apr, 2015, 07:39: AM

Expert Answer:

Fiscal measures to control inflation include taxation, government expenditure and public borrowings. The choice of fiscal measures for controlling inflation depends on the causes of excess demand as follows- 

  1. Government expenditure: When excess demand is caused by the government expenditure in excess of real output, the most effective measure is to cut down on the public expenditure. A cut in the public expenditure reduces not only the government’s demand for goods and services but also private consumption expenditure. Therefore, the excess demand decreases more than a given cut in the public expenditure.
  2. Taxation: When excess demand is caused by private expenditure such as the expenditure by the households and firms, taxation of income is a more appropriate measure to control inflation. Taxation of income reduces the disposable income. As consumer demand is a function of disposable income, consumer demand decreases due to taxation. Thus, a well-designed taxation policy reduces aggregate demand and thereby brings the inflation under control.
  3. Public borrowing: Borrowings by the government to fund budget deficits uses idle money lying with banks and financial institutions for productive functions by investing it. When the Government borrows money from the market, it reduces the purchasing power of the public.

Answered by  | 22nd Apr, 2015, 09:39: AM

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