Fiscal Policy

1. Introduction

1.1 Definition

• Fiscal Policy refers to the use of government spending and taxation to influence the economy.
• It is a key tool of macroeconomic management.

1.2 Objectives

• Stabilize the economy
• Promote economic growth
• Control inflation
• Reduce unemployment
• Achieve equitable distribution of income

1.3 Key Players

• Central Government
• Parliament
• Ministry of Finance
• Budget Committee

1.4 Historical Context

• 1930s: John Maynard Keynes introduced the concept of Keynesian Fiscal Policy.
• Post-WWII: Governments adopted Expansionary Fiscal Policy to stimulate recovery.
• 1970s-80s: Shift towards Contractionary Fiscal Policy to control inflation.
• 2008 Global Financial Crisis: Expansionary Fiscal Policy was used to stimulate economies.

1.5 Fiscal Policy vs Monetary Policy

2. Types of Fiscal Policy

2.1 Expansionary Fiscal Policy

• Definition: Increase in government spending or decrease in taxes to boost economic activity.
• Examples:
  • New public projects (e.g., infrastructure)
  • Tax cuts on income or corporate taxes
• Impact: Stimulates demand, increases GDP, may lead to inflation.
• Used during:
  • Recession
  • Economic slowdown
  • High unemployment

2.2 Contractionary Fiscal Policy

• Definition: Decrease in government spending or increase in taxes to reduce inflation.
• Examples:
  • Budget cuts in public services
  • Higher income tax rates
• Impact: Reduces demand, lowers inflation, may slow economic growth.
• Used during:
  • High inflation
  • Budget deficits
  • Economic overheating

2.3 Neutral Fiscal Policy

• Definition: Government maintains a balanced budget, neither increasing nor decreasing spending.
• Purpose: To maintain economic stability.
• Used when:
  • Economy is at full capacity
  • Inflation is under control
  • Unemployment is low

2.4 Discretionary vs Automatic Fiscal Policy

3. Implications on Economy

3.1 Economic Growth

• Expansionary Policy can boost GDP in the short term.
• Contractionary Policy may slow growth but stabilize the economy in the long run.

3.2 Inflation

• Expansionary Policy can lead to inflation if demand outstrips supply.
• Contractionary Policy helps control inflation by reducing demand.

3.3 Employment

• Expansionary Policy increases government spending, leading to job creation.
• Contractionary Policy may reduce employment if it leads to reduced public spending.

3.4 Public Debt

• Expansionary Fiscal Policy often increases public debt.
• Contractionary Fiscal Policy helps reduce budget deficits.

3.5 Income Distribution

• Progressive taxation and public spending can reduce inequality.
• Regressive taxation may widen income gaps.

3.6 Examples from Indian Context

3.7 Key Facts for Exams (SSC, RRB)

• Fiscal Policy is a tool of macroeconomic management.
• Keynesian Theory forms the basis of Expansionary Fiscal Policy.
• Discretionary Fiscal Policy is used during recessions.
• Automatic Fiscal Policy includes unemployment benefits and social security.
• Contractionary Fiscal Policy is used to control inflation.
• Fiscal Deficit is the difference between government expenditure and revenue.
• Revenue Deficit is the gap between revenue receipts and revenue expenditures.

3.8 Important Terms

• Fiscal Deficit: Expenditure > Revenue
• Revenue Deficit: Revenue Expenditure > Revenue Receipts
• Primary Deficit: Fiscal Deficit - Interest Payments
• Capital Expenditure: Spending on infrastructure, machinery, etc.
• Revenue Expenditure: Spending on salaries, subsidies, etc.

3.9 Differences

3.10 Summary Table