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Fiscal Policy in India

Meaning
• The word fiscal means ‘state treasury’ and
fiscal policy refers to policy concerning the
use of ‘state treasury’ or the government
finances to achieve the macroeconomic goals.
• Fiscal policy involves the decisions that a
government makes regarding collection of
revenue, through taxation and about
spending that revenue.
• It is sister strategy to monetary policy
through which a central bank influences a
nation’s money supply.
Introduction
 Fiscal Policy is a part of macro economics.
 This policy is also known as budgetary policy.
One major function of the government is to
stabilize the economy.
Current Indian govt wants to achieve fiscal
deficit target by not reducing expenditure but
increasing tax collection.
Keynesian economics, when the government
changes the levels of taxation and governments
spending, it influences aggregate demand and the
level of economic activity.
Objectives of Fiscal Policy
1.Development by effective mobilisation of
resources
2.Reduction in inequalities of income and
wealth
3.Price stability and control of inflation
4.Employment generation
5.Reducing the deficit in the balance of
payment
6.Increasing national income
7.Development of infrastructure
Two Types of Fiscal Policy
There are two types of fiscal policies. Both of
these policies work well for the overall growth of
the economy. But the government use one of
them at times when one is required more than
the other.
Let’s talk about both of these.
1 – EXPANSIONARY FISCAL POLICY:
2 – CONTRACTIONARY FISCAL POLICY:
• 1 – EXPANSIONARY FISCAL POLICY:
This policy is quite popular among the people of the country because
through this, consumers get more money in their hands and as a result
their purchasing power increases drastically.
The government uses this by two ways. Either they spend more money
on public works, provide benefits to the unemployed, spend more on
projects that are halted in between or they cut taxes so that the
individuals or businesses don’t need to pay much to the government.
You may think which one is more prudent! People who favour the
government spending prefer it over cutting taxes because they believe
that if the government spends more, the unfinished projects would be
completed.
On the other hand, individuals who prefer cutting taxes talk about it
because they believe that by cutting taxes the government would be
able to generate more cash into consumers’ hands.
Expansionary policy isn’t easy to apply for state government because
state government is always on a pressure to keep a budget that is
balanced. As it becomes impossible at local levels, expansionary fiscal
policy should be mandated from the central government.
Assume that the economy is initially in a recession. The equilibrium level
of real GDP, Y 1, lies below the natural level, Y 2, implying that there is
less than full employment of the economy’s resources.
The way out of this difficulty, according to the Keynesians, is to run a
budget deficit by increasing government expenditures in excess of
current tax receipts.
The increase in government expenditures should be sufficient to cause
the aggregate demand curve to shift to the right from AD 1 to AD 2,
restoring the economy to the natural level of real GDP. This increase in
government expenditures need not, of course, be equal to the
difference between Y 1 and Y 2.
Recall that any increase in autonomous aggregate expenditures,
including government expenditures, has a multiplier effect on aggregate
demand. Hence, the government needs only to increase its
expenditures by a small amount to cause aggregate demand to increase
by the amount necessary to achieve the natural level of real GDP.
Keynesians argue that expansionary fiscal policy provides a quick way
out of a recession.
2 – CONTRACTIONARY FISCAL POLICY:

As you can expect, a contractionary fiscal policy is just the opposite


of the expansionary fiscal policy. That means the objective of the
contractionary policy is to slow down the economic growth.
But why a government of a country would like to do that? The only
reason for which contractionary fiscal policy can be used is to flush
out the inflation.

However, it is a rarest thing and that’s why government doesn’t use


contractionary policy at all. The nature of this sort of policy is just
the opposite.

In this case, the government spending is cut as much as possible


and the rate of taxes is increased so that the purchasing power of
the consumer gets reduced.
Secondary effects of fiscal policy. Classical economists point out that the
Keynesian view of the effectiveness of fiscal policy tends to ignore the secondary
effects that fiscal policy can have on credit market conditions. When the
government pursues an expansionary fiscal policy, it finances its deficit spending
by borrowing funds from the nation’s credit market. Assuming that
the money supply remains constant, the government’s borrowing of funds in the
credit market tends to reduce the amount of funds available and thereby drives
up interest rates. Higher interest rates, in turn, tend to reduce or “crowd out”
aggregate investment expenditures and consumer expenditures that are sensitive
to interest rates. Hence, the effectiveness of expansionary fiscal policy in
stimulating aggregate demand will be mitigated to some degree by
this crowding‐out effect.
The same holds true for contractionary fiscal policies designed to combat
expected inflation. If the government reduces its expenditures and thereby
reduces its borrowing, the supply of available funds in the credit market
increases, causing the interest rate to fall. Aggregate demand increases as the
private sector increases its investment and interest‐sensitive consumption
expenditures. Hence, contractionary fiscal policy leads to a crowding‐in effect on
the part of the private sector. This crowding‐in effect mitigates the effectiveness
of the contractionary fiscal policy in counteracting rising aggregate demand and
inflationary pressures.
Secondary effects of fiscal policy. Classical economists point out that the
Keynesian view of the effectiveness of fiscal policy tends to ignore the secondary
effects that fiscal policy can have on credit market conditions. When the
government pursues an expansionary fiscal policy, it finances its deficit spending
by borrowing funds from the nation’s credit market. Assuming that
the money supply remains constant, the government’s borrowing of funds in the
credit market tends to reduce the amount of funds available and thereby drives
up interest rates. Higher interest rates, in turn, tend to reduce or “crowd out”
aggregate investment expenditures and consumer expenditures that are sensitive
to interest rates. Hence, the effectiveness of expansionary fiscal policy in
stimulating aggregate demand will be mitigated to some degree by
this crowding‐out effect.
The same holds true for contractionary fiscal policies designed to combat
expected inflation. If the government reduces its expenditures and thereby
reduces its borrowing, the supply of available funds in the credit market
increases, causing the interest rate to fall. Aggregate demand increases as the
private sector increases its investment and interest‐sensitive consumption
expenditures. Hence, contractionary fiscal policy leads to a crowding‐in effect on
the part of the private sector. This crowding‐in effect mitigates the effectiveness
of the contractionary fiscal policy in counteracting rising aggregate demand and
inflationary pressures.
Additional Info…..
Public Expenditure
• Public expenditure is spending made by the
government of a country on collective needs and
wants such as pension, provision, infrastructure,
etc.
• Public expenditure is an important component
of aggregate demand.
• Public expenditure include Revenue
expenditure and capital expenditure.
Concept of Deficit

• Revenue Deficit = Revenue Expenditure – Revenue


Receipts

• Fiscal Deficit = Total Expenditure (that is Revenue


Expenditure + Capital Expenditure) – Total Receipts (that
is all Revenue and Capital Receipts other than loans
taken)
Fiscal Reforms in India
• Simplification of taxation system
• Improving tax to GDP ratio
• Reduction in rates of direct taxes
• Reforms in indirect taxes
• Reduction in non-plan government expenditure
• Reduction in subsidies
• Closure of sick public sector companies
• Disinvestment of public sector units
• Efforts to reduce government administrative expenses
Public Debts
“ public debt is defined as any money owned by
a government agency”
• Internal borrowings
1. Borrowings from the public means of treasury
bills and govt. bonds.
2. Borrowings from the central bank
• External borrowings
1. Foreign investment
2. International organizations like World Bank
&IMF
3. Market borrowings