Question

"With an objective to reduce inflation, government may reduce public Expenditure." Discuss the rationale behind such a step which may be taken by the Government.

Hint:

When facing inflation, contractionary fiscal policies like reducing public expenditure can help control demand-pull inflation.

Answer 1

- When inflation rises, the government may reduce public expenditure to control inflationary pressures in the economy.
- Government spending, particularly on public services and welfare programs, contributes to higher aggregate demand (AD).
- By reducing expenditure, the government can lower AD, which in turn reduces pressure on prices, thereby curbing inflation.
- This step is especially important when inflation is demand-driven, i.e., when too much money is chasing too few goods.
- A reduction in public expenditure can also lead to lower consumption and investment, slowing down the economy, and stabilizing price levels. Conclusion: Reducing public expenditure is a contractionary fiscal policy aimed at reducing demand-pull inflation, by decreasing overall demand in the economy.