The fiscal policy implies the government’s policy to regulate economic growth in a country with the incurring of expenditure and raising revenues. It is based on the theory proposed by Keynes. He put forward the idea that the action of the government to increase or decrease taxes and government expenditure will impact the Aggregate Demand (AD) and thus, economic activity. Hence in the case of fiscal policy, the government’s decision holds the key to influencing growth levels in the economy. On the other hand, the Central Bank governs interest rates in the economy to affect growth in the economy.
The Fiscal policy revolves around two key issues – entities on which government should incur expenditure and, ways to bring up revenue.
The government decides on which items to expend based on the prevailing needs in the economy. Usually, a large chunk of money is devoted to the cause of social justice components such as health, education, etc. Further, the expenditure is incurred as per the exigencies of time.
Next comes the part of methods to raise revenue. The decision revolves around the finding as to whether to increase taxes, reduce expenditure on unimportant heads, or should the government look for borrowing more, etc.
Fiscal Policy is also referred to as the Budgeting policy as it deals greatly with the items contained in the Annual Financial Statement or Budget that are introduced by the government.
What are the objectives that Fiscal Policy seeks to achieve?
- Economic growth- Government can enhance the growth of an economy by adjusting the expenditure level in an economy. For eg. If the economy is experiencing depression, then, the government can decide upon decreasing taxes and thereby enhancing investments and spending. An increase in the same would lead to better economic outcomes.
- Inflation combating – Fiscal Policy can be used to stabilize the prices in the economy. If aggregate demand in an economy outstrips the aggregate supply then, the government can consider increasing taxes. It will further help in diminishing purchasing power of consumers and hence inflation level would come down.
- Full employment- The idea of fiscal policy is to ensure the enhancement of employment potential in the country. Public expenditure on social sectors like health, and education assists in creating job opportunities for people. This enables the country reaching full potential and sustain growth levels.
- The equitable allocation of resources is the aim of fiscal policy. Progressive taxation helps in taxing the people who have a higher potential to earn. This helps in bridging the gap between rich and poor. The government also assists the vulnerable sections of society by providing subsidies. This helps in reaching the overall objective of inclusive growth.
- Solidity in the exchange rate can be affected by the use of fiscal policy. For example, promoting exports by decreasing export duties levied on firms and increasing import duty
to abate expenditure on unwarranted imports helps in strengthening the exchange rate of the country.
- The government’s policy of incurring expenditure helps in the creation of capital assets. It has multiplier effects as it contributes to infrastructure making and also generating employment.
- With fiscal policy, governments spend more money for the welfare of backward areas and it helps in bringing in prosperity. The development of backward areas helps in ushering in inclusive growth.
The instruments of fiscal policy are as follows
The components of fiscal policy basically act as instruments of fiscal policy. 1. Public expenditure – the expenditure incurred by the government to create infrastructure, generate employment, and invite investment in an economy. An increase in public expenditure helps in the supply of more money in the hands of people and thereby picking up growth.
- Taxation policy if the government decides on raising and lowering taxes on people. It determines the quantum of mommy that remains with the public. A decrease in taxes helps in boosting the availability of money to the public and hence, consumption picks up. It further helps in augmenting economic growth. On the other hand, the government can increase direct taxes during the time of inflation in economic growth. Hence, taxation is an important instrument of fiscal policy.
- Public debt- Government can also take help from the public to raise money. The borrowing by the government is often used for financing projects of public utility. 4. Subsidy and transfer payments made by the government for the marginalized sections of society also help in effecting inclusive growth.
Type of Fiscal policy –
There are broadly three types of fiscal policy that are in application and, they are as follows 1. Expansionary fiscal policy – in this classification of fiscal policy, the government aims to enhance the expenditure or spending levels. It is practiced to pick up the economic growth and standard of living in the economy. It assists in demand creation and employment generation. Here, the ding by the government is relatively more than the revenue earned via levying taxes. There are chances of developing a budget deficit with this set of policies. This government has to do the difficult take if juggling between managing recession and budget deficit.
- Contractionary fiscal policy- this type of policy measure aims to diminish expenditures. It is usually followed when the economy is going through phases of higher aggregate demand, boom, and inflation. The government decides on spending less on infrastructure projects and thereby, decreasing the money that goes into the economy. For illustration, in times of boom, the government can increase the tax rate. It will help in putting breaks to the level of expenditure by the government.
- Neutral fiscal policy- it is called a balanced budget approach. The name itself suggests the significance that the revenue earned by the government (via taxation) is equal to the expenditure incurred by it. The government maintains equanimity in its spending and finance-raising decisions. There is no major development on account of spending as it is in consonance with the revenue received. Hence, the name is neutral fiscal policy.
Frequently Asked Questions (FAQs)?
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What is meant by Pro-Cyclical and Counter-Cyclical fiscal policy?
Recently, the Economic survey stressed these types of fiscal policy owing to the challenges posed by the pandemic.
In pro-cyclical fiscal policy, the decision by the government regarding making expenditures are in direct relation to the prevailing situation in the economy. For example, adopting a contractionary fiscal policy during the recession and an expansionary fiscal policy during the periods of expansion.
In counter-cyclical fiscal policy, the idea is to reverse the prevailing economic situation. The whole aim is to counter the prevailing economic conditions. In times of recession, the government will follow expansionary fiscal policy to increase economic growth. On the other hand in time of expansion, the policymakers decide to adopt contractions fiscal policy.
Thereby, both ways it helps in taking control of business cycles.
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Are there any chances that fiscal policy fails?
Yes. If the government is unable to predict accurately then fiscal policy might not translate into sound economic growth. For example, if the government predicts an upcoming recession and adopts an expansionary policy. If the recession doesn’t arrive, then, the government’s increased spending adds to already pitched-up growth.
