A Business Encyclopedia

Fiscal Policy

Definition: The Fiscal Policy implies the decisions taken by the government with respect to its revenue collection (through taxation), expenditure and other financial operations to accomplish certain national goals.

The government uses its expenditure and taxation programmes to generate the desirable effects or eliminate the undesirable effects on the production, employment and national income of the economy. The Fiscal Policy aims at ensuring a long-run stability of the economy, could be achieved only by controlling the short-run economic fluctuations. Thus, the fiscal policy strives to achieve the following objectives:

  • Promotion of employment, i.e. maintaining and achieving the full employment.
  • Maintaining or stabilizing the growth rate of the economy.
  • Maintaining or stabilizing the price levels in the market.
  • Promoting the economic development of underdeveloped countries.
  • Achieving the equilibrium in the Balance of Payments.
  • Economic justice and equity.

Any change in the government expenditure and taxation influences the economy. Such as when the government increases the public expenditure during the depression the aggregate demand for goods and services increases leading to an increase in the income. While on the reduction of taxes the personal disposable income increases resulting in the increased consumption and investment of people.

On the contrary, if the government decides to reduce the public expenditure with a view to curbing inflation, the aggregate demand reduces along with the reduction in employment, production, output, and price level. While on the reduction of taxes the disposable income also reduces resulting in a reduced consumption and investment expenditure. Thus, the government can tackle the inflationary and deflationary pressures in the economy by judiciously using the combination of its expenditure and taxation programmes.

The fiscal policy is considered as a tight or contractionary policy when the government revenues are more than its public expenditure, i.e. government budget is in surplus. Whereas the policy is said to be expansionary or a loose policy, when the government spending is more than the revenues, i.e., the government budget is in deficit. But however, the fiscal policy focuses not on the level of deficit, but rather on the change in the fiscal deficit. Such as a deficit of Rs 2 million reduced to Rs 1.5 million is said to be a contractionary fiscal policy, irrespective that the budget is still in deficit.

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