Question

How does the government use its instruments of taxation and public expenditure during inflation? Support your answer with reasons.

Answer 1

Taxes are compulsory payment made to government by the household and producing sector for using the general services in the economy. During inflation, the government increases the tax burden on the households and the producers which reduces the purchasing power in the economy by decreasing the real income thus correcting inflation in the economy.

Public expenditure includes all the expenditure incurred by government in the economy from its revenue. During inflation, the government cuts all its expenditure which acts like a 'withdrawal' from the circular flow of income in the economy. This reduces the purchasing power in the economy by reducing the income in the economy thus correcting inflation.