fiscal policy

Ppt 6
Fiscal policy
 Use of govt spending , taxes and debt
management to adjust employment , prices
and aggregate demand.
 Fiscal policy advocated by Keynes in 1930
Expansionary and contractionary
fiscal policy
 Expansionary fiscal policy: increasing govt
spending ,reduce taxes,or reduction in both
to increase aggregate demand.
 Contractionary fiscal policy: reducing govt

expenditure,increasing taxes or both to

reduce aggregate demand
objectives
 1. full employment : According to Keynes, the
level of employment can be increased by
raising the propensity to consume through
reduction in taxation and public investment
 2. Optimum allocation of resources : divert

resources from unproductive to productive

uses
 3. equitable distribution of income and

wealth : through progressive taxation and

savings transferring wealth from rich to poor
objectives
 4. Economic growth : increasing the rate of
capital accumulation through public
investment
 5. Price stability: protecting the economy fro

high rate of inflation

instruments
 Govt spending, taxes , savings and debt
management
 Govt spending:increase in govt expenditure

may increase employment, output, income

and demand
 Public expenditure in the nature of public

works, relief expenditure, subsidies,transfer

payments, and social security benefits
instruments
 Taxes: taxes determine the size of disposable
income of the people. A change in tax
structure influence aggregate demand and
employment
 Savings:Savings determine the level of private

spending
 Govt adopts compulsory saving schemes to

correct inflation
 Debt management: public debt may use to

manage the money supply in the economy.

Limitations
 1. it may destabilize the economy , decision
taking may be under the influence of lobies ,
newspaper reports and polls . Chances of
biases are more
 2. excess govt expenditure may lead to excess
aggregate demand and cause inflation
 3.when taxation laws are having loopholes it
may lead to tax evasion
 4. long implementation lag
 5. harm full to economic freedom , more govt
intervention
Compensatory fiscal policy
 Fiscal policy used by the govt to counter balance
fluctuations in national income and employment
is known as compensatory fiscal policy
 It combines deficit and surplus financing in
achieving balancing equilibrium
 During depression increasing govt spending or
reducing taxes or both
 During inflation reducing govt spending or
increasing taxes to correct inflation or both
 It works to counter balance changes in private
investment
Fiscal policy and stabilisation of
economic activities
 Objectives
 1.full employment
 2.price stability
 3.Economic growth
 4.Balance of payments equilibrium
Fiscal policy and stabilisation of
economic activities
 Full employment : during unemployment time
fiscal policy of expanding public spending
through deficit financing.
 2.Price stability : fiscal policy is used to cure

inflation
 Imposing new taxes , raise the rates of

existing taxes and reduce transfer payments ,

and reducing public expenditure . Depending
on the intensity of inflationary pressure these
measures may taken together or separately
Economic growth
 For increasing economic growth we need to
increase capital accumulation through public
investment.
 A suitable investment policy supported by

low interest rate is needed

 Public borrowing or deficit financing
 Creating best infrastructure may attract more

private investment
 Deficit financing for productive investment is

good
Balance of payment equilibrium
 Deficit in balance of payment can be
corrected by fiscal policy
 Inflation can be cured through increasing

taxes ,as disposable income reduced it will

reduce imports also
 A reduction in govt transfer payments will

lead to a reduction in aggregate consumption

and imports
Income policy
 The policy of the govt to regulate the rate of
growth of wages and earnings of the
labourers.
 Instruments of income policy
 1. wage controls : voluntary wage controls

and mandatory wage controls

 2. price controls
 Tax based income policy (TIP)
 Income policies are generally adopted to curb

wartime inflation.
instruments
 1. wage controls : govt imposed legislated
maximum wages. increae of wages should be
strictly proportional to the growth rate of labour
productivity.
 2.price controls : govt imposed rules or laws
that forbid the adjustment of prices to clear the
markets. price controls are introduced to
maintain the affordability of goods and services
 Floor prices and price ceilings
 Minimum price floor price
 Maximum price ceiling price
Contracyclical policy measures
 Stabilization policy:
 Govt policy aimed at reducing business cycle
fluctuations
 Objectives: steady growth of output , employment
and prices.
 Fiscal and monetary policies
 A contractionary fiscal policy adopted during
inflation
 Expansionary fiscal policy on deflation
 Contractionary monetary policy during inflation
 Expansionary monetary policy during deflation