Question

What are fiscal policies? How can the government correct the situation of inflation and deflation through fiscal policies?

Answer 1

Instructions:

• Explain the meaning of fiscal policies. Explain how an increase in tax rates can help in correcting inflation and how a decrease in tax rates can help in correcting deflation in the country.

Answer:

• Government's policy regarding public revenue, public expenditure, and public debt is called fiscal policy.
• These policies are implemented through the budget.
• The aim of fiscal policies are:
  • Attain economic stability
  • Create employment opportunities
  • Control unnecessary expenditures
  • Efficient allocation of resources
• To correct the situation of inflation, the tax rate is increased. As a result of this, the purchasing power of the people falls. For example, assume that the tax rate is increased from 10% to 20%. Then, for Rs. 100, the tax to be paid is Rs. 20 and the consumer can use only Rs. 80. When the products cannot be sold in the market,the prices fall.
• Similarly, tax is reduced at the time of deflation. This will increase the purchasing power of the people. For example, assume that the tax rate is decreased from 20% to 10%. Then, for Rs. 100, the tax to be paid is Rs. 10 and the consumer can use only Rs. 90. As a result the demand for products increases and the price of the products increases.