Comment on whether higher government spending will always increase inflation (6)

Inflation is the general increase of the price level within an economy. Government spending is a component of AD, therefore an increase to this component would cause AD to increase. The upward shift of AD will be enhanced by the multiplier effect in the economy, thereby resulting in a further upward shift of AD. The resulting increased AD means that there is higher demand for the same level of output, therefore resulting in demand-pull inflation. However, some forms of government spending may also affect the supply side, for example increased spending on education can improve long run productivity, this would shift out AS, helping to regulate inflationary pressure caused by the increased AD and therefore causing the price level to move back to its original state. It also depends on whether the increased spending is funded by increased taxation – if this is the case then consumer’s disposable incomes will be reduced, therefore reducing consumer spending, a separate component of AD; as government spending rises, consumer spending will fall and therefore inflationary pressure would be reduced. (answer aided by diagram)