Fiscal Policy

Fiscal Policy in India is the cornerstone of its

economic strategy, which steers the country through
various phases of growth, development, and challenges.
It plays crucial role in shaping the nation’s development
trajectory, influencing its macroeconomic stability, and
addressing socio-economic challenges.
Meaning of Fiscal policy
Fiscal policy refers to the economic policy that
involves the government changing the levels of
taxation and government spending in order to
influence Aggregate Demand and the level of
economic activity. The fiscal policy is concerned
with the raising of government revenue and
incurring of government expenditure
Definition of Fiscal Policy

Fiscal Policy refers to government policy in respect of public

expenditure, taxation and public debt. It is the means by which the
government adjusts its spending levels and tax rates to monitor and
influence a nation’s economy.

Fiscal policy is based on the principles of Keynesian economics, which

basically states that governments can influence macroeconomic
productivity levels by increasing or decreasing tax levels and public
spending.
 Objectives of Fiscal Policy in India
Some of the main objectives of fiscal policy in India can be seen as follows:

To mobilise additional resources into socially necessary lines of development

To achieve and maintain economic stability
To stabilize the price level.
To maintain the growth rate of the economy.
To maintain equilibrium in the balance of payments.
To raise standard of living of the citizens of the country.
To reduce extreme inequality in income and wealth
To provide the necessary incentives to the private sector for its healthy growth.
etc
 Tools of Fiscal Policy
Major tools of fiscal policy used by the government
are as follows:

1. Public Expenditure
It includes subsidies, transfer payments including
welfare programs, public works projects and
government salaries. By increasing or decreasing its
spending, the government can directly influence
economic activity. For example, more government
spending can increase demand, leading to higher
output and employment.
2. Taxation
The government can influence economic activity
through its taxation policy. By reducing taxes, the
government leaves individuals and businesses
with more income to spend and invest, which can
boost economic growth. Conversely, increasing
taxes can help cool down an overheated economy
by reducing the amount of disposable income
available.
Public Borrowing
Public borrowing refers to the means by which
governments finance their expenditures that exceed
tax revenues. Under it, the government raises money
from the domestic population or from abroad through
instruments such as bonds, NSC, Kisan Vikas Patra, etc.
Public borrowing is a common practice used to fund
public services, infrastructure projects, welfare
programs, and to manage the country’s fiscal policy.
Other Measures

Other fiscal measures adopted by the government include:

• Rationing and price control

• Regulation of wages
• Increase the production of goods and services.
 Difference between Fiscal Policy and
Monetary Policy
Fiscal Policy Monetary Policy

Definition It is a macro-economic policy used by the It is a macro-economic policy used by the

government to adjust its spending levels Central Bank to influence money supply
and tax rates to monitor and a nation’s and interest rates.
economy

Institutional Control Controlled by the Government Controlled by the Central Bank

Prime Objective To influence the economic condition To influence the money supply and
interest rates.

Major Tools Public Expenditure, Taxation, Public Bank Rate, Cash Reserve Ratio, Statutory
Borrowing etc Liquidity Ratio etc
Types of Fiscal Policies

Based on the economic conditions and the objectives that governments aim to achieve, fiscal policy can be categorized into three main types
 Cyclicality of the Fiscal Policy

The cyclicality of the fiscal policy refers to a change

in direction of government expenditure and taxes

based on economic conditions and fluctuations in

economic growth.
There are two types of cyclical fiscal policies:
1. Counter-Cyclical Fiscal Policy
It refers to the steps taken by the government that go against
the direction of the economic or business cycle.
For example, in a recession or slowdown, the government,
usually, takes the route of expansionary fiscal policy. This
increases expenditure and reduces taxes to create a demand
that can drive an economic boom. This increases the
consumption potential of the economy and helps soften the
recession.
Pro-Cyclical Fiscal Policy

It refers to the type of fiscal policy wherein the government reinforces the
business cycle by being expansionary during good times and
contractionary during recessions.

Pursuing a pro-cyclical fiscal policy is generally regarded as dangerous as

it could raise macroeconomic volatility, depress investment, hamper
growth and harm the poor. For example, adopting Contractionary Fiscal
Policy during a recession will reduce the government expenditure and
increase the taxes. This will further decrease the consumption potential of
the economy and deepen the recession.
 Related Concepts
1. Fiscal Deficit
Fiscal Deficit refers to the gap between the government’s
total expenditure in a given financial year and its total
revenue (excluding borrowings) in the same financial year. It
is expressed as a percentage of the Gross Domestic Product
(GDP) and is an indicator of the government’s financial
health.
Fiscal Consolidation

Fiscal consolidation is a process where

government’s fiscal health is improved by
reducing fiscal deficit to levels which is
manageable and bearable for the economy.
Improved tax revenue realization and better
aligned expenditure are important components of
fiscal consolidation.
Fiscal Drag
Fiscal drag is an economic term whereby inflation
or income growth moves taxpayers into higher tax
brackets. It occurs mainly due to Progressive
Taxation, whereby individuals are moved into
higher tax brackets because of inflation or
increased income.
Fiscal Neutrality

Fiscal neutrality is when a government taxing,

spending, or borrowing decision has or is intended
to have no net effect on the economy. Any new
spending introduced by a policy change that is
fiscally neutral in this sense is expected to be
entirely offset by additional revenues generated.
Thus, Fiscal Neutrality creates a condition where
demand is neither stimulated nor diminished by
taxation and government spending.
Crowding Out Effect
The crowding out effect is an economic theory
suggesting that increased government spending
leads to a reduction in private sector spending.
This phenomenon occurs because the resources
used by the government must come from
somewhere, typically through increased taxation
or borrowing. Thus, the private sector is left with
lesser resources to invest.
Pump Priming
Pump priming is the action taken to stimulate an
economy usually during a recessionary period,
through government spending, and interest rate
and tax reductions. Pump priming involves
introducing relatively small amounts of
government funds into a depressed economy in
order to spur growth.
Economic Stimulus
An economic stimulus is the use of monetary or fiscal
policy changes to kick start growth during a recession.
Governments can accomplish this by using methods
such as lowering interest rates, increasing government
spending and quantitative easing, to name a few.
In the wake of COVID-19 Pandemic, the Government
announced 3 tranches of economic stimulus under the
Atma Nirbhar Bharat Programme.
Frequently Asked Questions (FAQs) on
Fiscal Policy in India

1. What is Fiscal Consolidation?

Fiscal Consolidation refer to improving
government’s fiscal health by reducing fiscal
deficit.
Who Prepares Fiscal Policy in India?

Fiscal Policy in india is formulated by the Finance

Ministry of the Central or State Governments.
What are the three types of Fiscal Policy?

Based on the objective, there are three types of

fiscal policies – Expansionary, Contractionary and
Neutral.