Fiscal Policy by Neeraj Bhandari ( Surkhet,Nepal )
• FISCAL POLICY IS : GOVERNMENT SPENDING, TAXING AND
• TOOLS TO PROMOTE FULL EMPLOYMENT, PRICE STABILITY, AND
RAPID ECONOMIC GROWTH.
• ACCORDING TO SAMUELSON, “IT IS CONCERNED WITH ALL THOSE
ACTIVITIES WHICH ARE ADOPTED BY THE GOVERNMENT TO
COLLECT REVENUES AND MAKE THE EXPENDITURES SO THAT
ECONOMIC STABILITY COULD BE ATTAINED WITHOUT INFLATION AND
• Development by effective Mobilization of Resources
• Efficient allocation of Financial Resources
• Price Stability and Control of Inflation
• Employment Generation
• Increasing National Income
• Development of Infrastructure
• Foreign Exchange Earnings
1. Expansionary Fiscal Policy
• Expansionary fiscal policy uses increased government spending, reduced
taxes or a combination of the two.
• The chief objective of a fiscal expansion is to increase aggregate demand
for goods and services across the economy, as well as to reduce
@ Expert Insight
Expansionary fiscal policy has a multiplier effect, in which each
dollar spent by government generates additional demand across
the economy, according to Professor Gregory Mankiw , a Harvard
economist and former White House adviser.
2. CONTRACTIONARY FISCAL POLICY
• When government policy-makers cut spending or increase taxes, they
engage in contractionary fiscal policy.
• Governments may enact contractionary measures to slow an economic
expansion and prevent inflation.
Economic fluctuations independent of policy actions by government
often affect the level of tax revenues, forcing elected officials to alter
fiscal policy. For example, economic recessions reduce output and
employment, resulting in reduced revenue for government coffers. This
often forces policy makers to consider contractionary measures, such as
increasing revenues by raising taxes or cutting government spending.
1. Taxes/ Taxation Policies
These are involuntary payments from the
household sector to the government sector.
Taxes are the primary source of revenue used by
government to finance government spending.
Taxes affect the amount of disposable income
available for consumption and saving. As such,
any change in taxes indirectly affects aggregate
expenditures and the macro economy through
consumption expenditures and investment
expenditures (via saving).
2. Public expenditure / Government
• It refers to government expenditure on public or
final goods and services.
• Public expenditure is an important component of
aggregate demand. Therefore, excess demand
can be corrected by reducing government
expenditure. Reduction in government
expenditure also leads to a decline in the volume
of national income due to the backward operation
of investment multiplier. Reduction in national
income leads to a decline in aggregate demand
and fall in the price level.
4. Public borrowing:
Like tax and public expenditure, public
borrowing is also an important anti –
inflationary instrument. Government of a
country should resort to borrowing from the
non-bank public to keep less money in their
hands for correcting the state of excess
demand and inflationary situation. On the
other hand, to correct deficient demand,
government should reduce borrowing from
the general public so that purchasing power
in the hands of the people is not reduced.
Rather, government should repay the past
loans to the people to increase their
4. Deficit financing
Besides the above fiscal measures, government
should resort to deficit financing to correct
deficient demand. Deficit financing is a technique
of financing a deficit budget by ( I ) printing notes,
& ( ii ) borrowing from the central bank or drawing
down the cash balances on part of the
government from the central bank. In any case,
deficit financing makes an addition to the total
money supply of the country and can correct
deficient demand. However, deficit financing
beyond a limit may produced inflationary
situation in a country. Therefore, deficit financing
must be kept within a limit and should be used
with caution and care.
• A budget is a statement of expenditures and receipts. If
expenditures exceed receipts, then a budget deficit occurs.
• If receipts exceed expenditures, then a budget surplus
occurs. While households, businesses, and other entities
have budgets, fiscal policy is most concerned with
• In particular, fiscal policy, especially that undertaken by the
federal government, is commonly evaluated in terms of
budget deficits and surpluses.
The Budget Deficit
• A government’s budget deficit is the difference
between what it spends (G) and what it collects in
taxes (T) in a given period:
BUDGET DEFICIT = G - T
FUNDING THE DEFICIT
DEFICIT=Expenditure > Revenue
CONSUMING THE SURPLUS
SURPLUS=Revenue > Expenditure
Fiscal policy is used to address business-cycle instability
that gives rise to the problems of unemployment and
inflation, that is, to close recessionary gaps and inflationary
• Recessionary Gap: A recessionary gap exists if the existing
level of aggregate production is less than what would be
produced with the full employment of resources. This gap
arises during a business-cycle contraction and typically
gives rise to higher rates of unemployment.
• Inflationary Gap: An inflationary gap exists if the existing
level of aggregate production is greater than what would be
produced with the full employment of resources. This gap
typically arises during the latter stages a business-cycle
expansion and typically gives rise to higher rates of
• Monetary policy is the process by
which the monetary authority of a
country controls the supply of money,
often targeting a rate of interest to
attain a set of objectives oriented
towards the growth and stability of the
• Manipulating the supply of money to
influence outcomes like economic
growth, inflation, exchange rates with
other currencies and unemployment.
• Central Bank (e.g. U.S. Federal
Reserve or European Central Bank)
• Interest rates; reserve requirements;
currency peg; discount window;
quantitative easing; open market
• Fiscal policy is the use of government
expenditure and revenue collection to
influence the economy.
• Manipulating the level of aggregate
demand in the economy to achieve
economic objectives of price stability,
full employment, and economic growth.
• Government (e.g. U.S. Congress,
• Taxes; amount of government spending
FISCAL POLICY MONETARY POLICY