Inflation as described is the phenomenon of general rise in prices and hence implies decrease in the purchasing power of a country’s currency. Inflation has its own benefits and ill-effects over the economic state of a country and has varying impact on the life of people across the country. The benefits and ill effects of inflation are discussed below:
- With moderate rise of inflation, wages tend to revise upwards and hence tend to decrease unemployment.
- Inflation allows the central bank of the country to control the rate of interest at which open market operations and interbank transactions are carried out. Thus, a means of liquidity control.
- Inflation tends to put pressure on costs of operations and hence for companies to shift resources away from the current schedule.
- Due to the decreasing value of money, people tend to not invest or save for the future.
- It leads of imbalance in balance of payments as the price rise in domestic country leads to falling exports and lowering exchange rate.
The main idea behind fiscal policy is to promote a regime of stable and sustainable growth of economy by means of adjustments in government spending, degree and form of borrowing, and taxation. With the recent incidents of economic crisis, governments across the world have stepped in to support the country’s financial system, mitigate the impact of crisis and put the economy back on growth track.
Fiscal policy directly results from the equation for GDP that comprises of public and private consumption (C), investments (I), government spending (G) and net exports (NX) i.e. GDP = C + I + G + NX. The government can control GDP by directly controlling G and indirectly influencing I, C and NX by means of changes in taxation, transfers and subsidies, and spending. Expansion policies tend to increase the aggregate demand by increased government spending whereas, contraction policies tend to do the reverse by decreased government spending e.g. cutting spending or raising taxes to tame inflation. Thus, based on the current state of the economy and the business cycle, government can employ various measures.