The government will use discretionary fiscal policy to control inflation by:
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → Borrowing from the public
Inflation comes when demand is more than the output the economy can produce. To control it, the government must reduce demand. When the government borrows from the public, it sells bonds to people. The money people put into these bonds is no longer in private hands. If the government does not spend this money, people are left with less to spend and invest, and demand falls.
Option (1) Reducing the tax rate — Incorrect. Lower taxes leave people with more disposable income, so they spend more and demand rises.
Option (2) Purchasing goods and services — Incorrect. Government purchases are part of aggregate demand. More purchases raise demand and push prices up.
Option (3) Increasing government spendings — Incorrect. Higher spending adds to demand. If firms cannot produce more at the current prices, prices rise.
Option (4) Borrowing from the public — Correct. The money lent to the government is taken out of people’s hands. If the government does not spend it, private spending and demand fall.
NCERT (2026-27): “Stabilisation Function of Government Budget The government may need to correct fluctuations in income and employment. The overall level of employment and prices in the economy depends upon the level of aggregate demand which depends on the spending decisions of millions of private economic agents apart from the government. … On the other hand, there may be times when demand exceeds available output under conditions of high employment and thus may give rise to inflation. In such situations, restrictive conditions may be needed to reduce demand.… Other Perspectives on Deficits and Debt: One of the main criticisms of deficits is that they are inflationary. This is because when government increases spending or cuts taxes, aggregate demand increases. Firms may not be able to produce higher quantities that are being demanded at the ongoing prices. Prices will, therefore, have to rise. … This is because if the government decides to borrow from private citizens by issuing bonds to finance its deficits, these bonds will compete with corporate bonds and other financial instruments for the available supply of funds. If some private savers decide to buy bonds, the funds remaining to be invested in private hands will be smaller.…” |