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Question: Why might an increase in government expenditure give rise to inflation?
Solution
Introduction
When the general price level of any economy rises, then inflation occurs. The price level may rise due to many factors like when the companies increase the salaries of the people; the house owners increase the rent of houses when the price of home rises in the economy. Then, it may also rise when the more money start to get printed in the economy by the central bank of that country on the demand of the government and there are various other reasons too. One cause of inflation is the rise in the expenditure of the government. Whenever the spending by the government of any country rises, the money supply in the economy increases the prices rise and cause inflation. Not only the spending, but the rate of taxes also impacts the rate of inflation in the country. There are some tools that are government use to control the rate of inflation and deflation of the country. These tools are the monetary and the fiscal policy that include actions like CRR, SLR, bank rate, taxes etc. are changed for tackling the problem of inflation (Batstra, 2012). During the rise in the general price level, the government restores to contractionary fiscal and monetary policy and vice-versa. With this tool, the supply of the money in the economy falls and thus the price level comes down and inflation is controlled. It is the part of fiscal policy of the government that it increases or decreases its spending. With this solution or tool, the inflation is caused and controlled as well.
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This question is important to analyze because there are some economic variables that impact the economy’s health and they also influence the policy initiatives by the government. So the following analysis will help in explaining that why the inflation is caused when the government increase its spending.
The way by which an increase in government expenditure give rise to inflation
It is the responsibility of the government to take care of the economy whenever it faces any problem like the problem of inflation or deflation. Basically, the government takes care of its spending and borrowing so that it can make the economy stay stable and good. When the country is about to suffer from any crisis, the government takes steps to protect it and make the working of the country smooth. When the government spends, it is for the stimulation of the economic growth of the country. With the rise in the spending of the government, the supply of the money in the economy rises and thus inflation is caused. There are various ways in which the government spends in the economy that boosts it and thus the rate of inflation rises. With more spending, the money supply gets pumped in the economy and the inflation increases.
When the government spends more, inflation rises in the following ways:
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1. With the spending of the government rises and they spend in the job related schemes that aim to create the more jobs for the people, and then the people start to earn more. With the more earnings by the people, the purchasing power of the people rise, they start buying more goods and services in the economy (Hofmann, 2005). When they start buying more, they demand more, and then the prices of the goods are increased by the companies. They do this because they are able to sell more goods at the high prices (Argy, 2016). So, the people in the companies increase price of goods and services, the allover prices of goods and services rise and the inflation occurs in the economy.
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2. Then for the economic growth of the country, the government tries to invest in the infrastructure of the country. The rise in the construction of the bridges and flyovers makes the economy prosper. The people are also required to work more and the raw materials are required to build the infrastructure. Thus, the spending of the government happens for the growths in the infrastructures that makes the economy boom and increase the supply of money. One way by which this happens is the profits of the company. The company makes more profits when they get a chance of building the flyovers and they earn profits (Nevile, 2015). These profits are distributed in the company in the form of more salaries and wages. Thus the people buy more goods and services and the money increases in supply in the economy.
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3. Lastly, it can be said that the government spends more to buy the resources for the country. For example, the government buys any new technology from the outside world and uses it for the growth of the economy. With the new technology, the country start producing more, this distributes the income among the economy and the inflation rises.
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From the above discussion it can be concluded that the more expenditure by the government increases the supply of money in the economy and whenever the spending by the government of any country rises, the money supply in the economy increases the prices rise and cause inflation. Not only the spending, but the rate of taxes also impacts the rate of inflation in the country. But, inflation is not bad for the economy every time as this spending is useful when the country suffers from deflation and from the crisis.
References
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Argy, V.E. and Nevile, J. eds., 2016. Inflation and Unemployment: Theory, Experience and Policy Making. Routledge.
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Batstra, L. and Frances, A., 2012. Diagnostic inflation: causes and a suggested cure. The Journal of nervous and mental disease, 200(6), pp.474-479.
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Hofmann, B. and Remsperger, H., 2005. Inflation differentials among the euro area countries: potential causes and consequences. Journal of Asian Economics, 16(3), pp.403-419.
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Nevile, J.W., 2015. Inflation in Australia: causes and cures. Post-Keynesian Essays from Down Under Volume II: Essays on Policy and Applied Economics: Theory and Policy in an Historical Context, 2, p.232.
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