Fiscal Policy: Dr. Akshay Dhume

Fiscal Policy
Dr. Akshay Dhume
1
Meaning and Scope
 Fiscal policy means the policy of using ‘state treasury’ or
‘government finance’ to achieve macroeconomic goal
 It is 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 inequality and stabilization of economy’s growth
path
 Scope of fiscal policy comprises of fiscal instruments
and target variables
2
Objectives
 Full employment
 Price stability
 Accelerating the rate of economic development
 Optimum allocation of resources
 Equitable distribution of income and wealth
 Economic stability
 Capital formation and growth
 Encouraging investment
3
Fiscal Instruments
 Budgetary Policy
◦ Governments plan to keep the budget in balance, surplus or
deficit
◦ Expenditure = Revenue ⇒ Balanced Budget Policy
◦ Expenditure > Revenue ⇒ Deficit Budget Policy
◦ Expenditure < Revenue ⇒ Surplus Budget Policy
 Government Expenditure
◦ Government spending on purchase of goods and services
◦ Transfer payments – one-sided transactions – promote welfare
◦ Govt. expenditure – injection into the economy – adds to
aggregate demand
4
Fiscal Instruments (Contd.)
 Taxation
◦ Obligatory payment by people to government – no direct return to
taxpayer
◦ Taxes classification: Direct and Indirect Tax
◦ Direct Tax: Tax on Personal and Corporate Income, Property and
Wealth
◦ Indirect Tax: GST, VAT, Sales Tax
 Public Borrowings
◦ Internal Borrowing: From public through sale of government
securities and from central bank
◦ External Borrowing: Borrowing from foreign government,
international organizations viz. World Bank, IMF, etc. and market
borrowing
5
Government Expenditure
6
Government Receipts
7
Classification of Tax Revenue
8
Government Debt
9
Target Variables
 Target variables of fiscal policy are variables which are
sought to be changed through fiscal instruments
 Variables
◦ Private disposable income

◦ Private consumption expenditure
◦ Private savings and investment
◦ Exports and Imports
◦ Level and Structure of Prices
10
How Fiscal Instruments Affect Target
Variables
 Instruments and target variables are interrelated
 Government can affect aggregate demand
◦ By changing aggregate consumption expenditure, by changing
disposable income through direct taxation
◦ By changing imports through tariffs
◦ By changing investments through tax incentives/disincentive
◦ By changing government expenditure
11
Kinds of Fiscal Policy
 Automatic Stabilization Fiscal Policy
◦ Fiscal system with built-in-flexibility
◦ Automatic adjustment in government expenditure and tax
revenue in response to changes in output
◦ ↑ output → ↑ employment → ↑ income → ↑ tax revenue → ↓
govt. expenditure (automatically)
◦ Limitations
 Works when cyclical factors arise within the
economy due change in income and spending
 Does not work when economy is excessively
affected by external factors
12
Kinds of Fiscal Policy
 Compensatory Fiscal Policy
◦ Deliberate budgetary action taken by government to
compensate for deficiency in or reduce the excess of aggregate
demand
◦ Action taken in form of surplus/deficit budgeting
◦ Deficit budgeting is adopted to fight depression in the
economy
◦ Surplus budgeting is adopted during periods of high inflation
rates, especially when inflation is caused by excessive demand
13
Kinds of Fiscal Policy (Contd.)
 Discretionary Fiscal Policy
◦ Ad hoc changes are made in government expenditure and
taxation system at the discretion of government as and when
required by the economy
◦ Changes are made in
 Level and pattern of taxation
 Size and pattern of expenditure
 Size and composition of public debt
◦ Limitation
 Effective when used for short-run adjustments in economy
 Lack of reliable macroeconomic estimates and forecasts
 Time lags in implementation of fiscal action
14
Fiscal Policy and Macroeconomic Goals
 Fiscal Policy for Economic Growth
◦ Mobilization of Resources through Taxation
◦ Mobilization of Resources through Public
Borrowings
 Fiscal Policy for Employment
 Fiscal Policy for Stabilization
 Fiscal Policy for Economic Equality
 Fiscal Policy for External Sector Balance
15
Crowding-Out Effect
 Crowding-out: Fall in private investment due to rise in deficit
financing
 Government Expenditure > Tax Revenue
 Govt. borrows from central bank or from market through sale of bonds
 Two methods of borrowing force crowding-out
◦ Deficit spending financed through deficit financing leads to

inflationary pressures – central bank resorts to tight money policy –
leads to decline in private investment
◦ Deficit spending financed through market borrowing through sale of
bonds – bond prices go down and interest rate goes up – leads to
decline in private investment as cost of borrowing increases – also
public investment in bonds rises (given high interest rates) and that
in assets like land, building etc. falls
16
Crowding-In Effect
 Expansionary fiscal policy stimulates real economic
activity – leads to increase in income – provides
incentive for businesses to expand production –
businesses increase investment
 Expansionary fiscal policy leads to crowding-in effect
17

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Fiscal Policy

Dr. Akshay Dhume

◦ Private disposable income

 Two methods of borrowing force crowding-out

◦ Deficit spending financed through deficit financing leads to

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