FISCAL POLICY

Fiscal Policy
◦ ‘fisc’ means ‘state treasury’ and ‘fiscal policy’ refers to policy concerning
the use of ‘state treasury’ or the government finances to achieve certain
macroeconomic goals.
◦ Fiscal is related to government revenue, expenditure especially taxes
◦ Objective- used to cure recession and maintain economic stability in the
country.
◦ Authority- Concerned Ministries/ RBI/ GOI
Comprehensive Definition of Fiscal Policy

◦ “Fiscal policy is the government programme 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”
-------------------Dwivedi DN (2010)
Instruments of Fiscal Policy- Fiscal policy is implemented through fiscal
instruments also called ‘fiscal handles’, ‘fiscal tools’ and ‘fiscal levers’

1. Budgetary policy deficit or surplus budgeting

2. Govt. Expenditure
3. Taxation (direct and indirect)
4. Public investment/Borrowings
5. Transfer payments (grants and subsidies)
6. Wage Control
7. Rationing
Other Measures
1. Increase in Imports of Raw materials
2. Decrease in Exports
3. Increase in Productivity
4. Provision of Subsidies
5. Use of Latest Technology
6. Rational Industrial Policy
 1. Budgetary Policy
◦ Narrow sense - budgetary policy refers to government’s plan to keep its budget in balance, in surplus or in
deficit.
◦ When the government keeps its total expenditure equal to its revenue, as a matter of policy, it means it has adopted a
balanced-budget policy.
◦ When the government decides to spend more than its expected revenue, as a matter of policy, it is pursuing a deficit-
budget policy.
◦ when the government adopts a policy of keeping its expenditure substantially below its current revenue, it is
following a surplus-budget policy
2. Government Expenditure
◦ Government expenditure includes
◦ total public spending on purchase of goods and services,
◦ payment of wages and salaries to public servants,
◦ public investment,
◦ infrastructure development,
◦ transfer payments (e.g., pensions, subsidies, unemployment allowance,
◦ grants and aid,
◦ payments of interest, and
◦ A mortization of loans.

◦ The government expenditure is an injection into the economy: it adds to the aggregate demand
 3. Taxation
◦ A tax is a non quid pro quo payment [not “something for something”] by the people to the government,
◦ tax is a payment by the people to the government against which there is no direct return to the taxpayers
◦ Types:
◦ Direct taxes- include taxes on personal incomes, corporate incomes, wealth and property. Personal tax and corporate tax together
contribute nearly 50 percent of the gross tax revenue of the central government of India.
◦ Indirect taxes includes taxes on production and sale of the goods and services. Indirect taxes are also called commodity taxes. Eg.
GST
 4. Public Borrowings
◦ Public borrowings include both internal and external borrowings.
◦ The governments make borrowings, generally, with a view to financing their budget deficits.
◦ Internal borrowings
◦ (i) borrowings from the public by means of government bonds and treasury bills
◦ (ii) borrowing from the central bank.
◦ Impact on Economy: Borrowings from the public to finance budget deficit is, in effect, simply a transfer of purchasing power from
the public to the government, whereas borrowings from the central bank for financing budget deficits, i.e., monetized deficit
financing, is straightaway an injection into the economy.

◦ External borrowings include borrowings from

◦ (a) foreign governments,
◦ (b) international organizations like World Bank and IMF, and
◦ (c) market borrowings.
◦ Impact on Economy : It has the same effect on the economy as deficit financing.
 Working of Fiscal Policy for Price stability
◦ Price Stability and Budgetary Policy
◦ During inflation, fiscal policy aims at controlling excessive aggregate spending, while during depression it
aims at making up the deficiency in effective demand for raising the economy from the depths of
depression.
◦ During depression, contra cyclical policy is considered that implies unbalanced budgets. An unbalanced
budget during depression implies deficit spending. To make it more effective, the government may finance
its deficits by borrowing from the banks.
◦ During periods of inflation, the policy is to have a budget surplus by curtailing government outlays.
◦ Surplus budget has deflationary effect on national income while a deficit budget tends to be expansionary.
During depression when we need an increase in the flow of income, deficit budgets are desired.
Conversely, in inflation when we need to check the overflow of income, surplus budgets are favoured.
 Working of Fiscal Policy for Price stability
◦ Taxes and Price Stability
◦ Taxes determine the size of disposable income in the hands of general public and therefore, the quantum of
inflationary and deflationary gaps.
◦ During depression tax policy has to be such as to encourage private consumption and investment; while
during inflation, tax policy must curtail consumption and investment.
◦ During depression, a general reduction in corporate and income taxation has been favoured by
economists like Prof. A H. Hansen, M. Kalecki, and R.A. Musgrave on the ground that this leaves
higher disposable incomes with people inducing higher consumption while low corporate taxation
encourages ‘venture capital’, thereby promoting more investment.
◦ On the other hand, Mr. Kalecki expressed the view that the policy of reducing taxes for increasing
consumption and stimulating private investment is not a practical solution of the unemployment
problem because income-tax cannot be changed so often. The government will have to evolve a long-
term fiscal policy.
 Working of Fiscal Policy for Price stability
◦ During inflation, new taxes can be levied to wipe off the surplus purchasing power. Caution, however,
should be taken not to raise the taxes so high as to stifle new investment and generate a business recession.
Expenditure tax and excise duties are anti-inflationary in character. During inflation fiscal authority should
aim at levying such taxes as reduce current excessive demand for specific commodities rather than
aggregate demand.
◦ Redistributive taxation is probably the best measure for raising and stabilising the consumption function.
◦ Redistributive taxation implies a progressive tax structure. This implies taxing the high-income groups at higher rates, and the
middle and low-income groups at lower rates with a view to raising consumer spending.
 Working of Fiscal Policy for Price stability
◦ Public borrowings
◦ During depression, taxes are reduced and public expenditures are increased.
◦ Deficits are financed by borrowings from the public, commercial banks or the central bank of the country.
◦ The public borrowing of otherwise idle funds will have no adverse effect on consumption or on investment. When budgets are
deficit, it is very difficult to retire debts.
◦ In a period of inflation, public debt has to be managed in such a way as reduces the money supply in the economy and
curtails credit. The government will do well to retire debt through a budget surplus.
 Working of Fiscal Policy for Price stability
◦ Government expenditure
◦ During inflation, the best policy is to reduce government expenditure in order to control inflation by giving up such
schemes as are justified only during deflation.
◦ While expenditures are reduced, attempts are made to increase public revenues to generate a budget surplus.
◦ It is during depression that public spending assumes greater importance. A distinction is made between the concepts of
public spending during depression, that is, the concepts of pump priming and the ‘compensatory spending’. Pump
priming means that a certain volume of public spending will help to revive the economy which will gradually reach
satisfactory levels of employment and output. What this volume of spending may be is not specific. The idea is that,
when private spending becomes deficient, then a small dose of public spending may prove to be a good starter.
 Monetary Policy (MP) Vs Fiscal Policy (FP)
◦ About MP
• It regulates supply of money and the cost and availability of credit.
• It deals with both the lending and borrowing rates of interest for banks.
◦ Aim of MP-
• to maintain price stability, full employment and economic growth.
◦ MP
• influence money supply
• FP
• Linked to change in government revenue and expenditure
• broader tool of government.
• Used to overcome recession and control inflation.
MCQs
◦ 1. Fiscal policy in India is formulated by
◦ a) Reserve Bank of India
◦ b) Planning Commission
◦ c) Finance Ministry
◦ d) Securities and Exchange Board of India

◦ 2 : Fiscal deficit in the union budget is equal to 

◦ a) Net increase in internal and external borrowings
◦ b) The difference between current expenditure and current revenue
◦ c) The sum of monetized deficit and budgetary deficit
◦ d) Net increase in the union government’s borrowing from the Reserve Bank of India
◦ : Budget deficit may lead to 
◦ Rise in the interest rates
◦ Fall in value of currency
◦ Increase in currency circulation
◦ Which of the statements given above is/are correct?

◦ a) 1 and 2 only
◦ b) 1, 2, and 3
◦ c) 1 and 3 only
◦ d) 2 and 3 only
◦ 4: Which of the following developments can occur in an economy due to deficit financing?
◦ Rise in inflation
◦ Rise in government debt
◦ Increase in money supply
◦ Improvement in current account deficit

◦ Select the correct answer using the codes given below:

◦ a) 1 and 2 only
◦ b) 1, 3 and 4
◦ c) 2 and 4 only
◦ d) 1, 2 and 3
References
◦ RBI web link- https
://www.rbi.org.in/scripts/FS_Overview.aspx?fn=2752#:~:text=Monetary%20policy%20refer
s%20to%20the,ultimate%20objective%20of%20economic%20policy
.
◦ RBI. (2010). Implementation of Monetary Policy in India (Speech by Deepak Mohanty).
Retrieved from https://www.rbi.org.in/scripts/BS_SpeechesView.aspx?Id=498
◦ RBI. (2005). Master Circular - Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio
(SLR). Retrieved from https://www.rbi.org.in/Scripts/BS_ViewMasterCirculars.aspx?
Id=2377&Mode=0#:~:text=In%20terms%20of%20Section%2042,is%20empowered%20to
%20increase%20the
◦ The Economic Times. Definition of 'Statutory Liquidity Ratio'. Retrieved from
https://economictimes.indiatimes.com/definition/statutory-liquidity-ratio#:~:text=Definition
%20of%20'Statutory%20Liquidity%20Ratio'&text=Description%3A%20Apart%20from
%20Cash%20Reserve,cash%2C%20gold%20and%20unencumbered%20securities.