Inflation is caused by too many dollars chasing to few goods. More aptly stated, it defines a situation whereby the government spends more than it taxes,i.e. a budget deficit resulting in rising prices. If the government spends exactly the same as it taxes then there will be price stability in the economy. Deductively, we can then say that if the government spends less than it taxes we will see falling prices in the economy. The philips curve will be applicable in situation one and three, deficit spending and budget surplus.(posted 7526 days ago)In the deficit spending situation excess money is in the system which will cause the money to be discounted, i.e. rising prices. Since all production is consumed and the demand is still there it will appear that inflation is caused by growing economy. Conversly, if there is a surplus in the budget a liquidity squeeze will cause the economy to decline. Why? The econmony does not have sufficient funds to pay its tax bill let alone to create economic growth. Hence, the philips curve looks again at the result and predicts that a slowing economy will reduce inflation.
Therefore, the ideal situation occurs when the budget is balanced. At that point the result is real growth with stable prices and the philips curve really does die.
This, then, begs the question of what is a balanced budget?