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Chapter 13: Q2. (page 282)

What are the government’s fiscal policy options for ending severe demand-pull inflation?

Short Answer

Expert verified

Reduced government spending and amplified taxes are the fiscal options to regulate demand-pull inflation.

Step by step solution

01

Effects of decreased government spending

Fiscal policy has two instruments that are government spending and taxes.A contractionary budgetary policy of the government reduces government spending.Lower government spending will directly shrink the aggregate expenditure of the economy.

As a result, a lower income will pull the demand down to a lower aggregate demand and supply model equilibrium. Hence, prices will fall, and inflation will be controlled or halted.

02

Effects of high taxes

Another part of a contractionary fiscal policy is high taxes.As taxes rise, the disposable income of consumers declines. Consequently, the consumption expenditure and saving in the economy also contracts. Less amount of consumption reduces the aggregate expenditure.

On the other hand, lower saving pulls down the gross investment as the economy is stable when saving matches the investment. Therefore, the consumption and investment expenditure falls, bringing the equilibrium GDP down. A lower GDP will reduce the aggregate demand, and the prices will fall. Hence, higher taxes will regulate demand-pull inflation.

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Most popular questions from this chapter

Last year, while a hypothetical economy was in a recession, government spending was \(595 billion, and government revenue was \)505 billion. Economists estimate that if the economy had been at its full employment level of GDP last year, government spending would have been \(555 billion and government revenue would have been \)550 billion. Which of the following statements about this government’s fiscal situation are true?

  1. The government has a non–cyclically adjusted budget deficit of \(595 billion.

  2. The government has a non–cyclically adjusted budget deficit of \)90 billion.

  3. The government has a non–cyclically adjusted budget surplus of \(90 billion.

  4. The government has a cyclically adjusted budget deficit of \)555 billion.

  5. The government has a cyclically adjusted budget deficit of \(5 billion.

  6. The government has a cyclically adjusted budget surplus of \)5 billion.

In January, the interest rate is 5 percent and firms borrow \(50 billion per month for investment projects. In February, the federal government doubles its monthly borrowing from \)25 billion to \(50 billion, driving the interest rate up to 7 percent. As a result, firms cut back their borrowing to only \)30 billion per month. Which of the following is true?

  1. There is no crowding-out effect because the government’s increase in borrowing exceeds firms’ decrease in borrowing.

  2. There is a crowding-out effect of \(20 billion.

  3. There is no crowding-out effect because both the government and firms are still borrowing a lot.

  4. There is a crowding-out effect of \)25 billion.

What is the relationship between the multiplier and the AD component of government spending?

How do economists distinguish between the absolute and relative sizes of the public debt? Why is the distinction important? Distinguish between refinancing the debt and retiring the debt. How does an internally held public debt differ from an externally held public debt? Contrast the effects of retiring an internally held debt and retiring an externally held debt.

Which of the following would help a government reduce an inflationary output gap?

  1. Raising taxes

  2. Lowering taxes

  3. Increasing government spending

  4. Decreasing government spending
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