2. DEFINITION
Fiscal policy can be defined as the policy of the
government regarding changes in taxes, government
spending and government borrowing to affect aggregate
demand in the economy.
A policy under which government uses its expenditure
and revenue program to produce desirable effects and
avoid undesirable effects in the national income,
production and employment.
-Arthur Smith
3. DIFFERENCE
FISCAL POLICY MONETARY
POLICY
• Deals with taxation and
government spendings.
• Deals with money supply.
• Is administered by the
government through
various laws and policies.
• Is controlled by the central
bank (RBI) through
interest rates and lending
rates.
• Measures take time to get • Measures can be
4. OBJECTIVES
• The main objective of fiscal policy is to control inflation or
deflation in the market i.e. maintaining economic stability.
• It helps in diverting resources from undesirable channels to
desirable channels.
• Helps in achieving welfare objectives i.e. basically to reduce
inequalities between rich and poor and increase welfare.
5. STANCES OF FISCAL POLICY
• Neutral: This is the equilibrium phase for the economy. In
this case the government spending is entirely funded by tax
revenue and there is no need of borrowing.
• Expansionary: This is the phase where the government
spending exceeds tax revenue. This happens during the
time of recessions.
• Contractionary: This is the phase where the government
spending is lower than tax revenue. This is undertaken to
pay down government debt.
6. METHODS OF FUNDING
FROM WHERE DOES THE MONEY COME FROM?
• Recovery of loans: The central government grants loans to various
states inside and outside the country. When government recovers
these loans the government gets more money that it can now
utilize for the welfare.
• Disinvestment: Government holds equity or shares of the public
sector enterprises. It can raise funds by selling its holding in the
market. It leads to reduction in assets held by the government.
7. • Borrowings: It basically means that the government is
borrowing money from various institutions be it inside or
outside the country.
The government may choose to borrow funds from public
by issuing bonds or treasury bills. The government can also
borrow funds from financial institutions like world bank or
any other country.
• Taxes: The most effective way for the government is to
increase tax rates or impose new taxes.
8. INSTRUMENTS OF FISCAL POLICY
• Budgetary surplus and deficit
• Government expenditure
• Public debt
• Taxation
9. PUBLIC DEBT
• Public debt refers to borrowing by a government from within
the country or from abroad, from private individuals or
association of individuals or from banking and NBFIs.
It can be classified in three ways:
i. Internal and external
ii. Productive and unproductive
iii.Short term and long term
10. • Internal public debt: When the government borrows from
within the country be it from the citizens or financial institutions
or the central bank.
• This is called internal borrowing.
• External public debt: When the government borrows funds
from international market be it any financial institutions or any
nation in particular.
• Acquiring loan from outside is comparatively difficult as the other
party first studies the financial position of the country and then
only grants a loan.
11. • Productive debt: The debt that is expected to create
assets which will yield income sufficient to pay the principal
amount and the interest on it, is known as ‘productive debt’.
• In other words, they are expected pay their way, they are self-
liquidating.
• Unproductive Debt: On the other hand, unproductive
debt is the debt that is raised for financing unproductive
assets or heavy unproductive expenditures.
• Such a debt is a deadweight debt.
12. • Short Term Loan: The loans which are to be repaid
within a period of one year.
The loan provided usually is for a limited amount.
It is used to fulfil short term needs of the government.
• Long Term Loan : The loans which are to be repaid after
a period of one year.
The loan provided here can be for a huge amount.
It is very helpful for long term projects.
13. TAXATION
• Tax is a legal compulsory payment paid to the government
by the people.
• It is the most common and effective way for the
government to influence the aggregate demand in the
economy.
• There are two types of taxes
i. Direct Tax
ii. Indirect Tax
14. •Direct Tax: It is the tax where the liability to pay
and the incidence lie on the same person.
example: income tax, corporate tax, property tax etc.
•Indirect Tax: When the liability to pay and the
incidence of the tax lie on a different person.
example: sales tax, VAT, service tax etc.
15. • During the time of inflation (when aggregate
demand is more than aggregate supply) the
government increases the tax rates and may also
impose new tax rates.
• This would result in reduction in the money
supply in the economy and will control the
inflationary gap.
16. • During the time of deflation (when aggregate
demand is less than aggregate supply) the
government reduces the tax rates and may also
cut of some taxes temporarily.
• This would result in an increase in the money
supply in the economy and will control the
deflationary gap.
17. BUDGETARY SURPLUS
• It is a situation where the revenue earned by government
is more than the expenditure.
• The surplus amount is used for repayment of loans or can
be kept as a reserve for the future.
• It can also be used to make desired purchases that were
delayed and for the development of the economy.
• It is a sign that the government is running the economy
efficiently.
18. BUDGETARY DEFICIT
• It is a situation where the revenue earned by the
government is less than its expenditure.
• At this time the government reduces its expenditure on
public welfare, increases tax rates and may also opt for
borrowings.
• The surplus from previous years can be used.
• It is a sign that the government is not running
efficiently.
19. GOVERNMENT EXPENDITURE
• During the time of inflation the government decides
to reduce its expenditure on public welfare like
police, military, courts, education etc.
• This results in the fall of aggregate demand.
• Which leads to reduction in the inflationary gap.
20. • At the time of deflation (when aggregate demand is
less than aggregate supply) the government decides
to increase its expenditure for the welfare of the
people.
• This injects money in the economy and helps remove
unemployment and increases the aggregate demand.
• It leads to reduction in deflationary gap.
21. FISCAL STRAITJACKET
• The concept of a fiscal straitjacket is a general
economic principle that suggests strict constraints on
government spending and public sector borrowing, to
limit or regulate the budget deficit over a time period.
• This term originated from the definition of straitjacket
(anything that severely confines, constricts, or hinders).
• Various states in the United States have various forms
of self-imposed fiscal straitjackets.
