 Fiscal policy is the policy which deals with the income and

expenditure of a government.

 It means that in which ways the govt. adjust its spending levels
and tax rates to monitor & influence a nation’s economy.

 It involves the decisions that a govt. Makes regarding the

collection of revenue through the taxation & spending the
revenue .

 Fiscal policy can be used to stabilize the economy over

the course of the business cycles.
According to Arthus Smithies :

Fiscal Policy is “ policy

under which the govt. Uses its expenditure and
revenues programmes to produce desirable effects
and avoids undesirable effects on the national
income , production and employment.”
 Objectives of Fiscal Policy.

General Objectives Objectives in Under developed

countries

 Price Stability.  To reduce income & wealth

 Exchange rate stability. inequality.
 Full Employment.  To Reduce regional Disparity.
 Economic Development  To eradicate poverty.
and growth.  Social justice.
 Built in stabilizers.  Mobilisation of Resources.
 Capital formation.
 Fiscal policy can be most effectively used to attain the
target of price stability during in both adversities of inflation
and deflation.

 Fiscal policy can also be used to establish exchange rate

stability by adopting adequate tax rate structure. The
balance of payment position can be checked by providing
tax concessions & subsidies on the inflow of foreign capital.

 The most important objective of fiscal policy is the

promotion and the maintenance of full employment in the
economy.
 Fiscal policy has developed as an established economic
function of a govt. Every country intends to use its public
finance to attain twin objectives of economic growth with
stability.

 Built instablizers refers to automatic changes in tax

collections and tr5ansfer payments of public expenditure
programmes so as to produce stabilizing effect on the
aggregate demand.
 There is a widening gap between the rich and the poor
in both income and wealth. Fiscal policy intends to reduce
inequality of income and wealth.

 Under developed countries, generally faces the problem

of regional disparities. Some areas are more rich to the
others. Developing countries always have the objectives of
reducing disparities with the help of fiscal policy.

 Poverty is curse for under – developed countries. Every

developing country through its fiscal policy aims at
eradicating poverty.
 Fiscal policy aims at providing social justice to the society.
Fiscal policy can serve as effective means of achieving the
goals of socialism in developed countries.

 Mobilization of resources is one of the most important

objective of fiscal policy in the under - developed countries .It
is of utmost importance to increase the rate of the investment
and capital formation to accelerate economic growth.

 Fiscal policy assumes a significant role in capital formation

in the developing countries . Developing countries , faces the
vicious circle of poverty, disguised unemployment and capital
deficiency.
 Taxes including direct and indirect taxes comprises the major
instruments of govt. Revenue.

The govt. Must collect adequate funds for launching

development programmes.

The sources are profit of corporate sector, profit of public sector

yet taxes are the major sources of govt. Revenue.

 Public Expenditure is the expenditure incurred by the central/

state govt. Or local bodies for satisfying common objectives.
 Public Debts The govt. Collects borrowing and loans
from the public to bridge the gap between income and
expenditure of the govt.

 Deficit Financing This is the technique by which deficit

between income and expenditure of the govt. Is fulfilled.
This can be done by imposing new taxes or by raising
loans .
The compensatory fiscal policy aims at continuously
compensating the economy against chronic tendencies
towards inflation and deflation by manipulating public
expenditures and taxes.

The compensatory fiscal policy has two approaches:

 Built-in -stabilisers; and

 Discretionary fiscal policy.

 The technique of built-in flexibility or stabilisers involves the
automatic adjustment of the expenditures and taxes in
relation to cyclical upswings and downswings within the
economy without deliberate action on the part of the
government.

 The various automatic stabilisers are corporate profits tax,

income tax, excise taxes, old age, survivors and
unemployment insurance and unemployment relief
payments.
Discretionary fiscal policy requires deliberate change in the
budget by such actions as changing tax rates or government
expenditures or both.

It may generally take three forms:

(i) Changing taxes with government expenditure constant,

(ii) changing government expenditure with taxes constant,

and

(iii) variations in both expenditures and tax simultaneously.

The budget Is the principal instrument of fiscal policy.
Budgetary policy exercises control over size and relationship
of government receipts and expenditures.

Budget Deficit—Fiscal Policy during Depression:

Deficit budgeting is an important method of overcoming
depression. When government expenditures exceed receipts,
larger amounts are put into the stream of national income
than they are withdrawn.

The deficit represents the net expenditure of the government

which increases national income by the multiplier times the
increase in net expenditure .
If the MPC is 2/3, the multiplier will be 3; and if the net increase in
government expenditure is Rs.-100 crores it will increase national
income to Rs. 300 crores (= 100 x 3).
45

E1 C + I + G’
C+I+G

E ----- A
^G C

Expenditure

Y Y1
Income
 Surplus in the budget occurs when the government
revenues exceed expenditures. The policy of surplus budget
is followed to control inflationary pressures within the
economy.

 It may be through increase in taxation or reduction in

government expenditure or both.

There may be budget surplus without government spending

when taxes are raised.
 45

E C1
T
Consumption E1

O Y1 Y
Income
 Another expansionist fiscal policy is the balanced budget.
In this policy the increase in taxes (∆T) and in government
expenditure (∆G) are of an equal amount.

 This has the impact of increasing net national income.

 This is because the reduction in consumption resulting

from the tax is not equal to the government expenditure.
Economic stability refers to minimum possible changes in
the internal price – level and foreign exchange rate.

Types of Stabilization

Fiscal Policy and Fiscal Policy

Inflation and Deflation
 Decrease in Public Expenditure one of the main causes
of inflation is increase in govt. Expenditure.

 Increase in Public Debts with a view to reducing private

expenditure , it is necessary to mop up the purchasing
power of the private sector through public borrowing.

 Increase in Taxes to check inflation govt. Should levy

new taxes and raise the rate of old ones.

 Over – valuation of Money one of the causes of inflation

is devaluation of the currency. Hence to check inflation , it
is essential to over – value it.
In case of deflation there is a tendency for the prices to fall.

 Increase in Govt. Expenditure under deflationary situation ,

govt. Expenditure must increases. As a result of it , demand
will increases. Increased demand will check the tendency of
the prices to fall.

 Decreases in Taxes During depression taxes should be

decreased . As a result of decrease in direct taxes like
income tax, corporation tax etc.. Then the investors & rich
sections of society will be prompted to invest more & spend
more on consumption.
 Increase in Social Welfare Expenditure Govt. Should
spend more on such social welfare activities as education,
public health and medical services roads , canals etc. With
a view to promoting public welfare.

 Pumping Priming during depression , private investment is

at lowest ebb. To increase it , public investment becomes
very essential . Increase in public investment serves as an
incentive to private investment . Such a policy is called
Pumping Priming.
How the Fiscal Policy of
the Under- developed
country is Different from
That of Developed
Country.
 Developed Countries
Aims at maintaining economic
stability which is essential for
progress of country.
Economic Stability is achieved
by regulating public expenditure
Taxation, borrowing and deficit
financing techniques are used
for mobilizing resources.
Fiscal policy aims at increasing
more & more consumption
Underdeveloped
Countries
Aims at achieving accelerated
economic growth.
There is no relevance.
Govt. Uses their own funds due
to the economic instability.
Under this, fiscal policy aims at
restraining consumption &
diverting resources towards
production.
 Lack of Accurate Forecasting Effective application of
fiscal policy is conditioned by the accurate forecasting of
depression and boom situations.

 Delay of Decisions In democratic countries , decisions

regarding fiscal measures must have the legislative
assemblies or the parliament . It is a long and time
consuming process.

 Conflicting Trends in Public and Private Sectors There

are conflicting trends in public and private sectors of
mixed underdeveloped economies .
 Conflict between Social and other Economic objectives
During the period of depressions , govt. Spends large
resources on public works programmes. But during boom
period , public expenditure is discontinued.

 Increase in Public Debt With a view to solving the

problems of depressions and unemployment , govt. Resorts
to large scale public debt.

 Problems of Deficit Financing Most of the govt. In

underdeveloped countries resort to large scale deficit
financing for economic development but beyond a
particular limit it becomes a potential source of inflation.