Answer to Question #88236 in Macroeconomics for Mubeen

Question

Analyse how fiscal policy measures could reduce inflation.

Answer 1

    Inflation is a situation when general price level of an economy rises. This generally happens due to excess of aggregate demand over aggregate supply. The gap between the two leads to very high prices and puts unusual pressure on an economy. Such, situation can create great disturbances in the economy and needs to be stabilized. Fiscal policy measures basically include stabilization measures through changes in the government expenditure as well as in tax structure.

     For curbing inflation government reduces expenditure which reduces aggregate demand bringing a reduction in the gap between aggregate demand and supply. This, in turn curbs inflation in the economy. The situation of inflationary gap where, aggregate demand exceeds aggregate supply at full employment level is often eased through government intervention by changing the structure of government expenditure.

    Apart from reducing government expenditure another measure that can be taken to control inflation is through increase in taxes. Increased taxes whether on personal income or corporate income reduces the quantity of disposable income available for spending in an economy. Such attempt causes reduction in aggregate demand and bring prices at a lower level thus, reducing inflation and inflationary gap.