Role of Functional Finance in Inflation and Deflation

Role of Functional Finance in Inflation and Deflation:

Role of Functional Finance in Inflation:

Inflation is the result of excessive private expenditure, and, therefore, fiscal tools must be used to check inflationary tendencies. This can be done in various ways:

(1) By spending less.

(2) By imposing new taxes and raising the rates of existing taxes, will transfer resources from private use to government use.

(3) The government may borrow money to prevent private expenditure from increasing.

(4) The government can increase the interest rates by increasing Bank Rate and may induce people to save more and consume less.

(5) The government may sell goods and services to the public in greater amounts than before.

In short, inflationary tendencies may be checked, when new taxes are imposed, and the rate of expenditure is reduced. This implies that inflationary pressure may be checked by following a policy of surplus budget. And, hence, economic stability can be maintained.

Role of Functional Finance in Deflation:

Similarly, deflation or unemployment is the result of a deficiency in private expenditure. This deficiency in private expenditure can be overcome in several ways:

(1) The tax rates may be reduced so that more purchasing power is left in the hands of the individuals, this may encourage consumption.

(2) The government may increase its expenditure on old age, pension and unemployment benefits, etc., during the period of depression to encourage consumption, such expenditure is called transfer expenditure.

(3) The government may reduce the rate of interest and may lend liberally to private businessmen to encourage investment expenditure. But the reduction in the rate of interest may not be very effective in increasing private investment, especially in times of depression when businessmen may become too pessimistic that they would not invest even if the rate of interest were reduced to zero.

(4) Thus, when the reduction in the rate of interest does not increase the level of investment in the private sector, the government may undertake public works programme during the depression to employ the unemployed person so that the total consumption expenditure may increase.

(5) The government may sanction subsidies and grants to the backward and underdeveloped sectors of the economy such as agriculture. It may grant interest-free loans to some other sectors of the economy to increase investment expenditure.

(6) It may repay its debts and thus, increase the purchasing power in the hands of the individuals which may increase consumption and investment expenditure.

All these are measures to fight depression which tend to increase the purchasing power in the hands of the individuals, and thus, may increase consumption expenditure, which in turn would induce private firms to undertake more investment. Hence, employment and income both will increase, and economic stability can be maintained.

But, all those measures, which increase the purchasing power in the hands of the individuals and encourage consumption and investment expenditure, are the result of an excess public expenditure over public revenue, which means a deficit budget. Hence, it can safely be concluded, that a policy of deficit budget should be followed to fight depression.