Maulana Azad National Institute of

Technology
(Department of Management Studies)

FISCAL
POLICY
 To study…
• Introduction
• Objectives
• Types of fiscal policy
• Constituents of fiscal policy
• Fiscal Capacity, Fiscal Deficit ,Fiscal
Imbalance
• Fiscal policy and Interest rates
• Limitations Of Fiscal Policy
• Fiscal Policy and Economic Growth
• Fiscal Policy Vs. Monetary Policy
 What Does Fiscal Policy Mean?

Government spending policies that

influence macroeconomic conditions.
These policies affect tax rates, interest
rates and government spending, in an
effort to control the economy.
• Fiscal policy refers to government
attempts to influence the direction of the
economy through changes in government
taxes, or through some spending (fiscal
allowances).
 Instruments of fiscal policy
• The two main instruments of fiscal policy
are government spending and taxation i.e.
Fiscal policy is carried out by the executive
and legislative branches of government,
and refers to tax policy and government
spending on goods and services.
 How Fiscal Policy Works?

• Fiscal policy is based on the theories of British

economist John Maynard Keynes. Also known as
Keynesian economics, this theory basically
states that governments can influence
macroeconomic productivity levels by
increasing or decreasing tax levels and public
spending. This influence, in turn, curbs inflation
(generally considered to be healthy when at a
level between 2-3%), increases employment and
maintains a healthy value of money.
When The Economy Needs Fiscal Policy?

• When inflation is too strong, the economy

may need a slow down. In such a situation,
a government can use fiscal policy to
increase taxes in order to suck money out of
the economy. Fiscal policy could also
dictate a decrease in government spending
and thereby decrease the money in
circulation.
 Objectives of fiscal policy
• Economic Development & Growth: By creating
conditions for increase in savings & investment.
• Employment: By encouraging the use of labor-absorbing
technology
• Stabilization: fight with depressionary trends and
booming (overheating) indications in the economy
• Reduction of disparities of income: By reducing the
income and wealth gaps between the rich and poor.
• Price stability: employed to contain inflationary and
deflationary tendencies in the economy
 Types of Fiscal Policy :
• A neutral stance of fiscal policy implies a balanced
budget where G = T (Government spending = Tax
revenue). Government spending is fully funded by tax
revenue and overall the budget outcome has a neutral effect
on the level of economic activity.
• An expansionary fiscal policy would be used to speed up
the rate of GDP growth or during a recession when GDP
growth is negative (G > T) . A tax cut and/or an increase in
government spending would be implemented to stimulate
economic growth and lower unemployment rates. These
policies will lead to higher federal budget deficits.
• A contractionary (restrictive) fiscal policy involves
raising taxes or cutting government spending in an attempt
to dampen GDP (aggregate demand) growth and lower
inflationary pressures (G < T) .
 Constituents of fiscal policy
• Public Expenditure
• Taxation
direct tax
Indirect tax
• Public borrowing
Fiscal policy responses to economic
instability
1) Discretionary Fiscal Policy: deliberate
changes in tax rates.
2) Automatic stabilizers:
a) Changes in tax revenues
b) Unemployment compensation and welfare
payments.
 Fiscal Capacity
The ability of groups, institutions, etc. to
generate revenue. The fiscal capacity of
governments depends on a variety of
factors including industrial capacity,
natural resource wealth and personal
incomes.
 Fiscal Imbalance
Fiscal imbalance is the term used by governments
to describe a monetary imbalance between the
national government and smaller, subordinate
governments, such as those of states or provinces
 A vertical fiscal imbalance occurs when the
revenues of different levels of government do not
match their expenditure responsibilities
 A horizontal imbalance occurs when different
regions of a country have different abilities to
provide services due to different abilities to raise
funds. This can occur if regions are able to raise
more funds through their tax bases than other
regions and/or the cost of provision of services is
higher in some regions than in others.
 Fiscal Deficit
• When a government's total expenditures
exceed the revenue that it generates
(excluding money from borrowings).
Deficit differs from debt, which is an
accumulation of yearly deficits
 Limitations Of Fiscal Policy
• Lags in fiscal policy
• Problems in tax policy
• Burden of public debt
Fiscal Policy and Economic
Growth
Fiscal Policy Vs. Monetary Policy
• Fiscal Policy is • Monetary Policy is
managed by Govt. maintained by Central
Bank.
• Deals with money supply
• Deal government control of ,(i) the supply of
policy that attempts money, (ii) availability of
to influence the money, (iii) cost of money
direction of the or rate of interest, in order
economy fiscal to attain a set of objectives
allowances. oriented towards the
growth and stability of the
economy.