Understanding Inflation, Fiscal Policy, and Government Budgets

Posted on Feb 19, 2025 in Economy

Understanding Inflation

Inflation: is a general increase in prices.

CPI: [(Current year CPI – Previous year CPI) / Previous year CPI] * 100

Core CPI: CPI less the evolution of unprocessed foods and energy products.

GDP Deflator: [(Current year deflator – Previous year deflator) / Previous year deflator] * 100 or (Nominal GDP / Real GDP)

Causes of Inflation

Inflation occurs due to:

Increased Demand

  • Monetarist View: Inflation occurs when the money supply increases beyond production increases.
  • Keynesian View: Inflation is produced by increasing aggregate demand, especially in situations of full employment.

Increases in Costs

Inflation is produced by increases in the costs of production, such as wages and raw materials.

Structural Inflation

An increase in aggregate demand leads to increases in the price level.

Effects of Inflation

  1. Loss of purchasing power: the same amount of money can buy less.
  2. Creating uncertainty and mistrust for consumers, businesses, savers, and the public sector.
  3. Negative impact on employment: products lose competitiveness, leading to increased imports and declining domestic production and employment.

Measures to Prevent Inflation

  1. If it is demand-pull inflation, it is necessary to reduce aggregate demand by using restrictive policies.
  2. If it is cost-push inflation, policies of supply are pursued, i.e., policies that provoke increases in aggregate supply.

Effects of Fiscal Policy on the Economy

Increasing public spending and cutting taxes leads to increased disposable income, consumption, investment, aggregate demand, employment, prices, and production, and vice versa.

The State’s General Budgets (PGE)

Public Revenue of PGE

Public revenue is obtained from:

  • Social Contributions: Amounts workers pay to be insured for coverage in disease, disability, retirement, etc.
  • Tributes: The most important revenue, accounting for half of the proceeds, classified as:
    • Taxes: Payments without receiving anything in return.
    • Fees: Payment for something.
  • Other Income: Current transfers (lottery), property income (profits of companies), sale of investments (privatization of companies, phone, etc.), capital transfers.

PGE Public Expenditure

The set of expenditures by the Public Administration, classified as:

  • Current Expenditures: Public services aimed at providing health, education, etc. (staff salaries, purchases of goods and services from private companies).
  • Investment Expenditures: To maintain and expand production capacity in the country.
  • Transfers and Grants: Funding in terms of taxes, social contributions, etc.

PGE Analysis

Roughly two factors are key in the PGE analysis:

  • Public spending: It indicates the government’s objectives in the budget.
  • Budget balance: Income – expenditure.

Budget Balance

  • Keynesian Economic Model: The state must borrow to achieve full employment and stability.
  • Neoliberal Policies: Critics of the indebtedness of the state. The main objection is that the deficit generates inflation by increasing the amount of money circulating in the economy.

Two Types of Deficit

  • Cyclical Deficit: A transitional hard time that the state takes to revive the economy.
  • Structural Deficit: It is permanent and remains even in situations close to full employment and is a drag on economic development.

Ending the Deficit

To end the deficit, the state can choose to:

  • Issue public debt.
  • Raise taxes.
  • Increase the money in circulation.