Fiscal Policy and Price Stability

Fiscal Policy and Price Stability:

The objective of economic growth and price stability has sometimes been regarded as antithetical. But this is a highly oversimplified view and it distorts the issue. At present, there is a general agreement that economic growth and stability are joint objectives for underdeveloped countries to pursue. Stagnation is regarded as too heavy and unacceptable a price to pay for the achievement of stability. At the same time, the evils of Inflation are such that no one would today recommend large-scale inflation as a means for promoting the economic development of under-developed countries. Though some economists have favored gentle rising of prices as an incentive for capital formation, they have emphasized that large-scale inflation would retard economic growth. In fact, the debate today is “not over the desirability of economic growth and stability, but only over the interrelationships between them and over the policies necessary to achieve them.”

Thus, fiscal policy should aim at curbing inflationary pressures inherent in a developing economy. In such an economy there is always an imbalance between the demand for and supply of real resources. Because of large-scale investment and repeated push of investment expenditure into capital goods industries, demands rise, but supply remains relatively inelastic due to structural rigidities, market imperfections, and bottlenecks, which impede the supply of essential goods. This leads to an inflationary rise in prices. A rise in the prices of basic commodities tends to generate a demand for higher wages and the rise in the level of wages would push up the costs leading to the creation of a wage-price spiral. Thus, demand-pull inflation tends to generate cost-push inflation in a developing economy.

The fiscal measures that can be taken to check inflationary tendencies are taxation and borrowing as these measures remove purchasing power from circulation. However, the fiscal measures must be supplemented with monetary measures to make them more effective, Besides, efforts must be made to increase production, especially of essential commodities.

Though the deflationary trend is not so common a characteristic of developing economies as that of rising prices if such a situation occurs, fiscal policy along with other instruments of economic policy must operate in coordination with each other.

The fiscal role of the government should also include the removal of bottlenecks and structural rigidities, planned development of the various sectors of the economy, physical controls of essential products, their purchase and sale by the government, and granting of subsidies and protection to essential consumer goods industries in the economy to maintain stability in the general price level.

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