If the primary goal is to reduce inflation, which of the following fiscal policy actions would...

If the primary goal is to reduce inflation, which of the following fiscal policy actions would be appropriate during a period of a rapidly increasing consumer price index? I. Reduce government expenditures for defense and nuclear energy research. II. Increase transfer payments to those most severely affected by the rising price index. III. Increase personal income tax rates.

Expert Solution

The inflation is rapidly increasing and the goal is to reduce the inflation in this case. Moreover, Inflation is being caused by rapidly rising consumer price index.

To reduce inflation the government has to use the contractionary fiscal policy in order to decrease aggregate demand so that the prices could decrease.

Increasing transfer payments to those mostly affected by the rising price index will not help as it will increase the inflation further. Hence this option will not be used.

Reducing government expenditure for defence and nuclear energy research is a less preferred option than increasing personal income tax rates. This is because the inflation is being caused by rising consumer price index, hence the most effective option would be to decrease consumer spending. For this, raising personal income tax rate would be a better option because it will reduce the disposable income and therefore reduce consumer spending more rapidly which will reduce inflation.

Hence, option III is correct. i.e, increase personal income tax rates.

Rahul Sunny answered 8 months ago

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