Fiscal Policy

Fiscal policy is a policy under which the government uses its expenditure and revenue programmes to produce desirable effects and avoid undesirable effects on the national income, production and employment. In ordinary words, fiscal policy refers to a policy that affects macroeconomic variables, like national income, employment, savings, investment, price level, etc. It is

also know as budgetary policy.

Objectives of Fiscal policy:

1. Optimum allocation of economic resources. The aim is that fiscal policy should be so framed as to increase the efficiency of productive resources.To ensure this, the government should spend on those public works which give the maximum employment.

2. Equitable distribution of wealth and income. It means that fiscal policy should be so designed as to bring about reasonable equality of incomes among different groups by transferring wealth from the rich to the poor.

3. Maintain price stability. Deflation leads to a sharp decline in business activity. On the other extreme, inflation may hit the fixed income classes hard while benefiting speculators and traders. Fiscal policy has to be such as will maintain a reasonably stable price level thereby benefiting all sections of society.

4. Achievement and maintenance of full employment because through it most other objectives are automatically achieved.

Types of Fiscal Policy:

1.Expansionary fiscal policy: It is defined as an increase in government expenditures and/or a decrease in taxes that causes the government's budget deficit to increase or its budget surplus to decrease. 

2.Contractionary fiscal policy: It is defined as a decrease in government expenditures and/or an increase in taxes that causes the government's budget deficit to decrease or its budget surplus to increase.

Instruments of Fiscal Policy:

1. Tax

It is a compulsory contribution made by the people and entity to the government. It is one of the major sources of the government revenue which is imposed by the government at various rates depending upon its policy. By changing the tax rates, the government can significantly affect the behavior and operation of economic agents and hence influence the targeted policy variables such as economic growth, employment, price etc. Increasement in the tax decreases aggregate demand whereas reduction in tax rate increases the disposable income of the people and hence aggregate demand increases.

2. Government Expenditure

Government  expenditures include normal government expenditures, capital expenditures on public works, relief expenditures, subsidies of various types, transfer payments and social security benefits. During inflation, the best policy is to reduce government expenditure in order to control inflation. While expenditures are reduced, attempts are made to increase public revenues to generate a budget surplus.

3. Government Borrowing

If the government exceeds revenue, it is financed through borrowing.  Government borrows from the following sources:

a. From banking and non-banking sectors through issuing treasury bills, development bonds and other government securities.

b. From other Country and international agencies like IMF, World Band, etc.

During inflation, borrowing becomes necessary. In a period of inflation,  public debt has to be managed in such a way as reduces the money supply in the economy.

Significance of Fiscal Policy:

1. To mobilize Resources

2. To accelerate the rate of growth.

3. To encourage the socially optimal investment.

4. Inducement to investment and capital formation.

5. Provide more employment opportunities.

6. Promotion of Economic Stability.

7. Reduction of inequality.

8. Subsidies in production

Some parts are adopted from: https://www.economicsdiscussion.net/fiscal-policy/fiscal-policy-objectives-and-instruments-trade-cycle-control/14669