explain why a one-shot permanent increase in government expenditure cannot generate inflation

Expert Solution

Increase in government expenditure tends to lead an increase in government budget deficit. It does not cause inflation primarily as no new money is added to the economy. To decrease tax, increase in government spending may increase the price of the certain sector but it does not meet the usual definition of inflation. Inflation is a monetary phenomenon, it can be created by more or rapid increase in the quantity of money supply than in output. So in one shot increase in government purchase cannot lead to inflation

If government continue to increase spending, the budget deficit will be increased at the high rate. then the government will borrow from the market by issuing bonds and government securities. This practice is called monetizing debt. This purchase adds money to the economy and can lead to price rise.

So in one shot permanent increase in government expenditure cannot generate inflation.

Rahul Sunny answered 2 years ago

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