Explain the role of government budget …

Government budget is of immense help in fighting the inflationary and deflationary tendencies. Inflationary tendencies emerge in the economy when aggregate demand exceeds aggregate supply. Thus government tries to decrease aggregate demand to remove inflationary pressures in the economy. To curb the inflationary tendency, the government can prepare a surplus budget. A surplus budget is one in which estimated receipts exceed the estimated expenses. Such a budget reduces the money supply in the economy. With a fall in the money supply, the purchasing power of people also falls, leading to a fall in the level of aggregate demand. As aggregate demand falls, the price level or the rate of inflation also falls.

Deflationary pressures emerge in the economy when aggregate demand falls short of aggregate supply. So, the government through its budgetary policies tries to increase AD. To curb the deflationary tendency, the government can prepare a deficit budget. A deficit budget is one in which estimated expenses exceed the estimated receipts. Such a budget increases the money supply in the economy. With the increase in money supply, the purchasing power of people also rises, leading to an increase in the level of aggregate demand. As aggregate demand rises, the price level also rises and the rate of deflation begins to fall.