Predict how the increased government spending might affect price stability.

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An increase in government spending is used as a means to bring the economy out recession. This is usually done by borrowing funds and is referred to as deficit spending. An increased spending by the government creates demand that provides an impetus for new businesses to start up and existing businesses to expand. It is essential to do this to increase employment and keep wages from dropping.

In the context of price stability, prolonged deficit (increased) spending can lead to inflation. This is especially true if there is an adequate demand for goods and services already. In addition to this, the buildup of deficit (through increased spending) deflates the currency and makes it more expensive to import raw material and goods from other nations which further increases prices.

To keep prices stable government spending should be increased only to provide an impetus to economic growth and gradually decreased to curtail inflation.

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There are many variables that play into the impact that increased government spending will have on price stability.  However, one impact that might result from excessive government spending is inflation.

If the government spends too much money (especially when it finances this spending by borrowing), inflation can occur.  This could happen for two reasons.  First of all, aggregate demand could go up with increased government spending.  People will have more money to spend, which will tend to drive price levels up.  Second, if government borrowing "crowds out" private borrowing, less investment will happen in the private sector.  This can suppress aggregate supply.  A decrease in aggregate supply can also cause prices to increase.

Overall, then, excessive government spending is likely to lead to inflation.

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