Fiscal Policy

By Kumar Devrat Rohita Mohit Shukla Nasreen Prashant Sharma

What is Fiscal Policy?

Fiscal policy involves the Government changing the levels of Taxation and Govt Spending in order to influence Aggregate Demand (AD) and therefore the level of economic activity. AD is the total level of planned expenditure in an economy C- is consumption , I- is Investment, G- is Government spending,
X- is total exports, and M- is total imports

AD = C+ I + G + X M

Reasons for Fiscal deficit

Increase in Subsidies Unproductive expenditure by the government Payment of Interest

Huge Borrowings

Defense Expenditure

Weak Revenue Mobilization Tax Evasion

Poor Performance of Public Sector

Objectives Of Fiscal Policies

Achieve desirable employment level Achieve desirable income distribution Increase in capital formation

Achieve desirable price level

Achieve desirable consumption level

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Types Of Fiscal policies

Expansionary Fiscal Policy

Contractionary Fiscal Policy

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Expansionary Policy / Loose

Involves increasing AD

Govt will increase spending (G) & Cut Taxes

Lower taxes will increase consumers spending because they have more disposable income(C)

This will worsen the govt budget deficit

Risk of High Inflation due to huge demand & increase in money supply

Contractionary Policy / Tight

Involves decreasing AD

Govt will cut spending (G) & Increase Taxes

High taxes will decrease consumers spending because they have less disposable income(C) This will help in improving the govt budget deficit

Not Easy to achieve this

Balancing Economy
Automatic Fiscal Stabilizer

Discretionary Fiscal Policy

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Tools Of Fiscal Policies

Public Expenditure

Income Of The Government Government Borrowings 9

Fiscal Responsibility And Budget Management (FRBM)

FRBM

Long-term macroeconomic stability Reducing revenue deficit

FRBM

FRBM

Reducing the Public debt

No Borrowing from the RBI

FRBM

Criticisms of Fiscal Policy

Disincentives of Tax Cuts.

Poor Informati on

Crowding out

Time lags

Implications of Fiscal policy

It will lead to capital infrastructure like higher education, growth and output. It help and facilitate trade and promote economic activity in the private sector. It will build up the framework for strong economic growth and working towards full employment. It will improve and promote in economic development.

IS-LM Curve

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Cont..
An increased deficit by the national government shifts the IS curve to the right. This raises the equilibrium interest rate (from i1 to i2) and national income (from Y1 to Y2), as shown in the graph. The equilibrium level of national income in the IS-LM diagram is referred to as aggregate demand. The graph indicates one of the major criticisms of deficit spending as a way to stimulate the economy: rising interest rates lead to discouragement of private fixed investment, which in turn may hurt long-term growth of the supply side

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AS-AD Framework
Price level
AS

P1

P0

AD1 AD0

Y0

Y1

Real GDP

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Governments Income
Direct and Indirect Tax Progressive Tax and Regressive Tax Non Tax Revenue
Administrative receipts Net contribution of Public sector undertaking Railways Posts and Telegraphs Currency and mint Other

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Public Debt
The government can turn to the capital markets to borrow the necessary money. Borrowings could be from the Reserve Bank of India (RBI), from the public by floating bonds, financial institutions, banks and even foreign institutions. Borrowing from capital market is done primarily by issuing securities, either Treasury Bills or Treasury Bonds

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Public Expenditure
Public expenditure is incurred in the form of purchases of goods and services, transfer payments and lending. Divided under two heads i.e. Plan Expenditure and Non Plan expenditure. The plan expenditure is developmental in nature. Plan expenditure refers to the expenditure incurred by the Central Government on Programs/Projects, which are recommended by the Planning Commission. According to the ministry of finance non-Plan expenditure is a generic term, which is used to cover all expenditure of Government not included in the Plan expenditure. It includes both developmental and nondevelopmental expenditure. Part of the expenditure is obligatory in nature e.g. interest payments, pensionary charges and statutory transfers to States. A part of the expenditure is an essential obligation of a State, e.g. Defense and internal security. Expenditure on maintaining the assets created in previous Plans is also treated as Non-plan expenditure.

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Thank You !