FISCAL POLICY

Fiscal policy is the policy related to revenue and expenditure of the government for achieving a set of definite objectives. The term ‘Fisc’ in English language means Treasury. Hence, policy relating to Treasury or government exchequer is called Fiscal Policy.

Objectives of Fiscal Policy

1)      Full Employment- Every government aims to maintain full employment in the country. To achieve this objective and to increase aggregate demand, government increases public expenditure and reduces taxes so that private sector can spend more. Increase in aggregate demand will lead to more production and employment.

2)      Price Stability- In case of rising prices, fiscal policy seeks to reduce aggregate demand by reducing public expenditure and increasing taxes. In case of falling prices, fiscal policy seeks to increase aggregate demand by increasing public expenditure and lowering the taxes.

3)      Reduction in Economic Inequality- To achieve this objective, progressive direct tax like income tax, wealth tax etc. are levied. The amount of tax thus collected by government is spent to provide facilities to weaker sections of the society.

4)      Economic Development- For economic development, fiscal policy seeks to increase the rate of capital formation. In an under-developed country, increase in the rate of capital formation is the sole determining factor to increase output and employment.

Instruments of Fiscal Policy


Fiscal Instruments Related to Government Expenditure


1)      Government Expenditure Policy- Aggregate demand is influenced by government expenditure. Aggregate demand increases with increase in government expenditure and vice versa. Government expenditure can be incurred to buy goods and services and in the form of transfer payments. Transfer payments are expenditure made on pensions, scholarship, education, medical facilities etc. Public expenditure incurred to buy goods and services has direct effect on aggregate demand while expenditure incurred in the form of transfer payments has indirect effect on aggregate demand.

Fiscal Instruments Related to Financing of Government Expenditure or Government Revenue

1)      Taxation Policy- Government collects large funds from the public in the form of taxes. Aggregate demand can be influenced through taxes. There are two types of taxes – Direct taxes and Indirect taxes. Direct taxes are levied on income and wealth of the individual. Indirect taxes are levied on goods and services. The monetary income of individuals decreases due direct taxes and prices of goods increases due to indirect taxes. In both conditions, aggregate demand falls.

2)      Public Debt Policy- Public debt refers to the amount collected by the government from public in the form of debt. The effect of public debt on aggregate demand depends on many factors. If private expenditure does not fall due to public debt, then by spending the amount collected through public debt, government can increase aggregate demand. But if private expenditure falls down due to public debt, then its effect on aggregate demand becomes doubtful.
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3)      Deficit Financing-It refers to the financing of the deficit of government’s budget. When the government meets its budgetary deficit by borrowing from the central bank, it is called deficit financing. As a result of deficit financing, income of the people goes up and aggregate demand increases.


Fiscal Policy to Correct Deficient Demand and Excess Demand

Fiscal Policy to Correct Deficient Demand
Fiscal Policy to Correct Excess Demand
1) Increase in public expenditure
1) Decrease in public expenditure
2) Decrease in taxes
2) Increase in taxes
3) Decrease in public debt
3) Increase in public debt
4) Increase in deficit financing
4) Decrease in deficit financing


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