Fiscal PolicyPresented by -

Komal Koya

Juhi Gupta

Parul Maroo

Hiren Patel

Saurabh Srivastava

Scope of the Presentation

• Meaning of Fiscal Policy

• Fiscal Instruments & Target Variables

• Kinds of Fiscal Policy• Automatic Stabilization Fiscal Policy

• Compensatory Fiscal Policy

• Discretionary Fiscal Policy

• Fiscal Policy & Macroeconomic Goals

• Limitations of Fiscal Policy

Meaning of Fiscal Policy

Fiscal Policy

• ‘Fisc’ means ‘state treasury’ and ‘fiscal policy’ refers to the policy concerning the use of ‘state treasury’ or the government finances ro achieve certain macroeconomic goals.

• Definition – Fiscal Policy is the government program of making discretionary changes in the pattern and level of its expenditure, taxation and borrowings in order to achieve certain economic goals such as economic growth, employment, income equality, and stabilization of the economy on a growth path

Fiscal Instruments and Target Variables

Fiscal Instruments

• Fiscal instruments refer to the budgetary measures which the government uses and manipulates to achieve some predetermined objectives.

• Type of Fiscal Instruments include –• Budgetary Policy – Deficit or Surplus Budgeting

• Government Expenditure

• Taxation

• Public Borrowings

Target Variables

• The target variable of fiscal policy, i.e., the variables which are sought to be changed through fiscal instruments are –• Private disposable incomes

• Private consumption expenditure

• Private savings and investment

• Exports and Imports

• Level and Structure of price

Kinds of Fiscal Policy

Kinds of Fiscal Policy

• There is no unique fiscal policy that can provide appropriate solutions to all kinds of economic problems and under different condition in different countries and at different point of time.

• However, fiscal policy actions are generally classified as –• Automatic Stabilization Fiscal Policy

• Compensatory Fiscal Policy

• Discretionary Fiscal Policy

Automatic Stabilization Policy

• The automatic fiscal policy means adopting a fiscal system with built-in-flexibility of tax revenue and government spending.

• Built in flexibility means automatic adjustment in the government expenditure and tax revenue in response to rise in fall in GDP

• As tax revenue increases the government expenditure decreases automatically, with increase in GDP. Tax revenue increases because household income increases with increase in GDP.

• Likewise, tax revenue decreases and government expenditure increases automatically, with the decrease in GDP and increase in unemployment

Limitation of Automatic Stabilization Policy

1. In reality automatic stabilization work only in the framework of the ideal model, and they work only when cyclical factors arise within the economy due to change in income and spending. The policy doesn’t work if inflation is caused by the factors other than the factors affecting aggregate demand.

2. This policy doesn’t work when an economy is over affected by external factors.

3. Automatic Stabilization model works efficiently only in the advanced economies – not in less developed countries.

Compensatory Fiscal Policy

• The compensatory is a deliberate budgetary acton taken by the government to compensate for the deficiency in, and to reduce the excess of, aggregate demand.

• The compensatory action is taken by the government in the form of surplus budgeting or deficit budgeting.

• Government has a greater degree of discretion than in automatic stabilization policy. It can be revised from time to time as per the need of the country.

• The policy of surplus budgeting is adopted when the convernmnet is required to control inflation and the policy of deficit budgeting is adopted when the objective is to control deflation.

Discretionary Fiscal Policy

• A discretionary fiscal policy is the one in which the ad hoc changes are made in the government expenditure and the taxation system and at the tax rates at the discretion of the government as and when required.

• In Discretionary Fiscal Policy, the government makes deliberate changes in –• The level and pattern of taxation

• The size and pattern of its expenditure

• The size and composition of public debt

Limitation of Discretionary Fiscal Policy

1. It is suitable and effective only when it is used for short-run corrections in the economy.

2. An important factor that makes effectiveness of discretionary fiscal policy doubtful in the short run is the problem in making an accurate assessment of the magnitude of the problem and the forecasting expected results of policy changes.

3. There are two kinds of time lags in the implementation of fiscal actions: pre-implementation and post-implementation. Pre-implementation time lag arrisesdue to time taken in the process of decision making called decision lag. Time lost in the implementation of the policy is called execution lag.

Fiscal Policy and Macroeconomic Goals

Fiscal Policy and Macroeconomic Goals

Fiscal Policy plays a vital role in Macroeconomic Goals which are –

• Economic Growth

• Mobility of resources through taxation

• Resource Mobilization through Public Borrowings

• Employment Promotion

• Economic Stability

• Economic Equality

• Maintaining BOP equilibrium

Limitations of Fiscal Policy

Limitations of Fiscal Policy

1. Formulation of an appropriate fiscal policy requires reliable forecasting of the target variables, viz., GNP, consumption, expenditure, investment, technological changes, etc.

2. The overall effect of changes in the policy instruments – government spending and taxation – is determined by the rate of dynamic multiplier which itself is difficult to forecast accurately. Also the working of dynamic multiplier has a time lag.

3. Decision and Execution Lags in case of Discretionary Fiscal Policy makes both working and efficacy of Fiscal Policy shrouded with uncertainity.

Limitations of Fiscal Policy

4. The working and effectiveness of fiscal policies in underdeveloped countries is severely limited by –

• Low level of incomes

• Small proportion of population in taxable income groups

• Existence of a large non-monetized sector

• All pervasive corruption and inefficiency in administration

5. In countries which are largely dependent on fiscal policy for their economic management and have inadequate scope for taxation, the government are forced to have resources to internal and external borrowings and deficit financing.

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