FISCALPOLICY

Maulana Azad National Institute of Technology

(Department of Management Studies)

To study…• Introduction• Objectives• Types of fiscal policy• Constituents of fiscal policy• Fiscal Capacity, Fiscal Deficit ,Fiscal

Imbalance  • Fiscal policy and Interest rates • Limitations Of Fiscal Policy  • Fiscal Policy and Economic Growth  • Fiscal Policy Vs. Monetary Policy 

What Does Fiscal Policy Mean?

Government spending policies that influence macroeconomic conditions. These policies affect tax rates, interest rates and government spending, in an effort to control the economy.

• Fiscal policy refers to government attempts to influence the direction of the economy through changes in government taxes, or through some spending (fiscal allowances).

Instruments of fiscal policy

• The two main instruments of fiscal policy are government spending and taxation i.e.

Fiscal policy is carried out by the executive and legislative branches of government, and refers to tax policy and government spending on goods and services.

How Fiscal Policy Works?

• Fiscal policy is based on the theories of British economist John Maynard Keynes. Also known as Keynesian economics, this theory basically states that governments can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending. This influence, in turn, curbs inflation (generally considered to be healthy when at a level between 2-3%), increases employment and maintains a healthy value of money.

When The Economy Needs Fiscal Policy?

• When inflation is too strong, the economy may need a slow down. In such a situation, a government can use fiscal policy to increase taxes in order to suck money out of the economy. Fiscal policy could also dictate a decrease in government spending and thereby decrease the money in circulation.

Objectives of fiscal policy

• Economic Development & Growth: By creating conditions for increase in savings & investment.

• Employment: By encouraging the use of labor-absorbing technology

• Stabilization: fight with depressionary trends and booming (overheating) indications in the economy

• Reduction of disparities of income: By reducing the income and wealth gaps between the rich and poor.

• Price stability: employed to contain inflationary and deflationary tendencies in the economy

Types of Fiscal Policy :

a) A neutral stance of fiscal policy implies a balanced budget where G = T (Government spending = Tax revenue). Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity.

b) An expansionary fiscal policy would be used to speed up the rate of GDP growth or during a recession when GDP growth is negative (G > T) . A tax cut and/or an increase in government spending would be implemented to stimulate economic growth and lower unemployment rates. These policies will lead to higher federal budget deficits.

c) A contractionary (restrictive) fiscal policy involves raising taxes or cutting government spending in an attempt to dampen GDP (aggregate demand) growth and lower inflationary pressures (G < T) .

Constituents of fiscal policy

• Public Expenditure

• Taxationdirect taxIndirect tax

• Public borrowing

Fiscal policy responses to economic instability

1) Discretionary Fiscal Policy: deliberate changes in tax rates.

2) Automatic stabilizers: a) Changes in tax revenues

b) Unemployment compensation and welfare payments.

Fiscal Capacity 

The ability of groups, institutions, etc. to generate revenue. The fiscal capacity of governments depends on a variety of factors including industrial capacity, natural resource wealth and personal incomes.

Fiscal ImbalanceFiscal imbalance is the term used by governments to describe a monetary imbalance between the national government and smaller, subordinate governments, such as those of states or provinces

A vertical fiscal imbalance occurs when the revenues of different levels of government do not match their expenditure responsibilities

A horizontal imbalance occurs when different regions of a country have different abilities to provide services due to different abilities to raise funds. This can occur if regions are able to raise more funds through their tax bases than other regions and/or the cost of provision of services is higher in some regions than in others.

Fiscal Deficit

• When a government's total expenditures exceed the revenue that it generates (excluding money from borrowings). Deficit differs from debt, which is an accumulation of yearly deficits

Limitations Of Fiscal Policy 

• Lags in fiscal policy

• Problems in tax policy

• Burden of public debt

Fiscal Policy and Economic Growth 

Fiscal Policy Vs. Monetary Policy 

• Fiscal Policy is managed by Govt.

• Deal government policy that attempts to influence the direction of the economy fiscal

allowances.

• Monetary Policy is maintained by Central Bank.• Deals with money supply control of ,(i) the supply of money, (ii) availability of money, (iii) cost of money or rate of interest, in order to attain a set of objectives oriented towards the growth and stability of the economy.