Fiscal Policy

Fiscal policy may be defined As that part of government economic policy which un taxation, expenditure, borrowing and the management of public debt in an economy. According to Arthus Smithies, Fiscal policy is a policy under which the government Uses is expenditure and revenue programmes to produce desirable effects and avoid undesirable ejectors on the national income, production and employment. Fiscal policy in short refers to the budgetary policy. It is an indispensable instrument of modem public finance. The importance of fiscal policy has greatly increased in modern times, both in developed as well as the underdeveloped countries of the world. In developed countries, fiscal policy is being increasingly used as an instrument to achieve full employment and economic stability. On the contrary, in underdeveloped countries, fiscal policy is more and more being used as a means to step up the rate of economic growth.

The fiscal policy primarily concerns itself with the flow of funds in the economy. Taxation, as it were, diverts the funds from the private sector to the governmental sector. Public expenditure, on the contrary, diverts funds from the governmental sector back to the economy. Public borrowing, like taxation, also diverts funds from the private sector to the governmental sector, but the two diversions influence the private sector in different ways. Management of public debts includes functions, such as floating of governmental loans, payment of interest thereon and retirement of matured debts. Fiscal policy, thus, exerts a very powerful influence on the working of the national economy. It directly affects the volume of output, income and employment in the economy. The greater the percentage of national income and expenditure represented by the governmental budget, the greater would be the influence of fiscal policy on aggregate economic activity.

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Modern Concept Of Fiscal Policy

According to the modern concept of fiscal policy, Fiscal policy is a technique to attain and maintain full employment by manipulating public expenditure as well as revenue in such a way to keep an equilibrium between effective demand and supply of goods and services as needed at that time.

Objectives of Fiscal Policy In Developed Economy

The main objectives of fiscal policy in a developed economy are :

To raise the level of investments,
To check the fluctuations in the effective demand for money.
To control the automatic process of the market.
To give proper direction to government investments.
To determine a suitable taxation policy.

Objectives Of Fiscal Policy in an Underdeveloped Economy

The nature of the fiscal policy in an underdeveloped economy is bound to be different from that of a developed country. In a developed economy, (as the economy is already fully developed), the problem is that of achieving economic stability on account of business fluctuations caused by the operation of the trade. In an underdeveloped economy, the problem is that of promoting rapid economic growth in the country,

The following could be major objectives of fiscal policy in an underdeveloped country:

To maximize the level of aggregate savings.
To maximize the rate of capital formation.
To divert the capital resources from less productive to more productive and from social less desirable to socially more desirable uses.
To curb the inflationary forces in the economy.
To eliminate as far as possible, sectoral imbalances arising in the economy from time to time.
To provide incentives for encouraging those industries which have a high employment potential in the economy.
To eliminate as far as possible the glaring economic inequalities and to bring about equitable re-distribution of income and wealth in the society.

The Objectives Of Fiscal Policy in A Developing Country Like India

Promotion and acceleration of capital formation in the public and private sectors.
Mobilisation of real and financial resources for the public sector without hampering the expansion of resources for the private sector.
Removal of unemployment.
Promotion and maintenance of economic stability.
Redistribution of national income.
Promotion and maintenance of price stability.
Fiscal policy and capital formation.
Fiscal policy and mobilisation of resources.

Developing countries suffer from a very low rate of voluntary private saving. The propensity to consume there is high and the propensity to save is very low resulting in deficiency of resources, mainly financial resources. For the mobilisation of financial resources, the following fiscal means may be used:

i) taxation,

ii)public borrowings,

iii) deficit financing, and

iv) stimulating private savings.

v) Removal of unemployment

There must be a harmonious combination to accelerate economic progress without inflation. In developing countries, the problem of unemployment is slightly different from that in a developed countries. As such, the fiscal policy shall have to be suitably modified to meet the requirements of developing countries like India. A developing economy, as it is well known, has generally to face two types of unemployment, namely, cyclical and disguised unemployment.

The cyclical unemployment in a developing economy originates generally from external causes. A cyclical recession in the advanced countries is, at once, transmitted to the developing counties through a fall in the prices of primary goods exported to these developed countries. In this way, export industries which constitute an important sector of these developing economies get depressed, resulting in cyclical unemployment in these countries.

There is a tendency for the price to rise on account of the large development expenditure which is seldom accompanied by a corresponding increase in production. However, a certain degree of inflation is both unavoidable and perhaps desirable in a developing economy. But if inflation goes too far, it distorts the economy and retards economic development. An anti-inflationary fiscal policy has, therefore, an important role in a developing economy.

Such fiscal policy involves a reduction in public expenditure, increase in taxation and public borrowings. However, reduction in government expenditure cause spending in the economy to decline and this keeps down the total demand. This is, however, not possible when investing in the public sector must of necessity expand. Hence reduction should be effected in the unnecessary expenditure of the government.

Here are the notes for Fiscal Policy During Inflation