CA Foundation · Business Economics · Public Finance
Inflation in an economy has risen sharply because aggregate demand exceeds supply. Which fiscal action is consistent with the stabilisation function of government?
Reducing government expenditure and raising taxes is consistent with stabilisation. Under demand-pull inflation, such contractionary fiscal policy lowers aggregate demand and eases price pressure. Expanding spending or cutting taxes would raise demand further, while healthcare or public utilities relate to allocation and distribution.
- AReducing government expenditure and raising taxesCorrect
- BIncreasing government expenditure and cutting taxes
- CProviding free healthcare to all citizens
- DSetting up a public sector undertaking to supply electricity
Explanation
When inflation arises from excess demand, the stabilisation function calls for contractionary fiscal policy: lower government spending and higher taxes reduce aggregate demand. The opposite option is expansionary and would worsen inflation. Free healthcare and a public electricity undertaking are allocation or distribution measures.
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