Transfer Payments is the other type of expenditure made by the government.

It is the
type of non-productive expenditure made by the nation’s government. These
expenditures are usually meant for social security for the citizens of a country, such as
old age pension, unemployment benefits, childcare benefits, differently abled allowances
etc. Moreover cost of providing various subsidies by government for the transformation
of business or firms are also consider as transfer payments.

Government may either use debt financing or capital financing for making these expenditures.
And to recover from debt or for capital refund government may either raise tax or print more
money in order to pay off the debt. If government raises tax to recover the debt, then business
and corporations will increase the price of goods and services to transfer the tax burden to
consumer that leads in increased price of all the goods and services, resulting in inflation.

Likewise, supply of money is the major cause of inflation in an economy. Money supply has
direct relation with the inflation. Velocity of money determines the perceived value of money in
the mind of public. Velocity here means the acceleration or circulation of money in an economy.
If any government utilizes more currency at higher rate than the growth rate of economy, the
perceived value of money decreases and this devaluation will drive price to increase thinking that
the currency is less worthy. Nonetheless, there will be more currency chasing few goods and
services which ultimately rise price of goods and services, hence resulting in inflation.

Moreover, Government expenditure is the component of Aggregate Demand and has positive
relation with price level. It is simply the combination of spending on consumption by
consumers+ investing expenditure on business components + government expenditure and
export – import. Aggregate Demand Curve is the model showing the relationship between price
level and the quantity of real GDP demanded by households, business corporation, government,
plus export minus import. And any increase or decrease in these components will lead to change
in overall Aggregate Demand which leads to shift in Aggregate Demand curve. As government
expenditure increases, price level increases which results in increased inflation, and vice versa.
Expenditures made by government will increase the overall Aggregate Demand and hence shift
aggregate demand curve toward right, which ultimately increase the equilibrium price and
quantity of goods and services and result in inflation. This can be explained by the below
diagram: