Fiscal policy and eco growth


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This lesson describes the role of fiscal policy in economic growth and development, the various instruments of fiscal policy, and their importance.

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Fiscal policy and eco growth

  2. 2. 2ECONOMIC GROWTH• Fiscal policy is an important tool for economicgrowth.• After full employment, governmentexpenditure can be used for economicgrowth.• Government investment can raise andinfluence private investment, income andemployment.– Private investment is influenced by profits.– During recession, private investment will not beforthcoming.Prabha Panth
  3. 3. 3Fiscal Policy and Growth• Economic growth refers to long periodexpansion of the GNP in real terms.• Fiscal measures – such as governmentinvestment increases economic growth.• Low interest rates can achieve bothstability and economic growth.• Increase in GDP and householdexpenditure encourages privateinvestment.Prabha Panth
  4. 4. 4• According to Hicks fiscal policy canhelp in economic growth.1) Public expenditure can contribute togrowth directly or by encouraging privatesector.2) Proper choice of revenue can mobilisefunds to finance expenditure and controlinflationary,3) Public debt and loan funds can providefor capital formation.4) Planning and providing for infrastructureand public utilities,Prabha Panth
  5. 5. 5Public expenditure1) To provide socio-economic overheadssuch aseducation, health, transport, power, water, and other infrastructure.2) Establish new industries, introducebetter agricultural methods andmarketing.3) Research and development activities,4) Public sector industries to provide basicgoods Prabha Panth
  6. 6. 6Tax Revenue• Finance to be raised for governmentexpenditure.• Taxes can be used to raise revenue, but– Very high profit tax can adversely affectprivate investment.– Very high income tax will affect fixed incomegroups and reduce their disposable income.– Indirect taxes will raise prices and causeinflation.Prabha Panth
  7. 7. 7Budget Deficits• During expansionary fiscalpolicy, government expenditure >government revenue.• So the gap has to be filled in throughdeficit financing,• This is done by borrowing funds from theCentral Bank,• Or ordering the CB to print more notes.Prabha Panth
  8. 8. 8Other sources of Finance1) Public sector profits – e.g. profits fromrailway sector, power, water, etc.2) Public services such ashospitals, colleges, schools,3) Fines, fees and charges,4) International loans from IMF, WorldBank, etc.5) Export earnings,Prabha Panth
  9. 9. 9Fiscal Policy and EconomicDevelopment• Government policy is useful fordeveloping countries. Most lessdeveloped countries do not have–strong industrial base,–infrastructure,–well developed banking system,–Or public utilities like power, watersupply, transport, etc.Prabha Panth
  10. 10. 10• Unorganised sector, unemployment,• Small private sector,• Concentration in agriculture and primarygoods industries• Lack of modern technology,• Inequalities in income and consumption,• High levels of povertyPrabha Panth
  11. 11. 11•Government expenditure is needed toensure economic development.•Government can invest in1) Infrastructure and basic industries,2) In Heavy industries,3) Power, water supply, transport,4) In education and health facilities,• Fiscal policy can be used to bring abouteconomic development and reduction inpoverty.Prabha Panth
  12. 12. 12• Government investment willencourage industrial development.• Provide infrastructure• Increase employment• Increase the organised sector,• Improve education and health status ofthe population,• Provide welfare schemes,• Reduce inequalities and poverty.Prabha Panth
  13. 13. 13Fiscal Measures1) Public Sector Investment: inindustries, financialsector, education, health, welfareprogrammes, etc.• But public sector should not aim atprofits,• It should provide these services atsubsidised rates to the population.• Hence it is necessary to have deficitrather than balanced budget.Prabha Panth
  14. 14. 14Taxation• Should be to divert resources towardspriority sectors.• High taxes on luxury and unnecessarygoods,• Lower taxes on necessary and prioritygoods.• Taxation should not be used to earnrevenue, but for reallocation of resources.Prabha Panth
  15. 15. 15Public Debt• The Government can borrow moneyfrom the Central Bank to finance itsdevelopment investment.• It can float loans to reduce money supplyin the hands of the rich,• This can be used to provide welfare andother measures for the poor.Prabha Panth
  16. 16. 16Deficit Financing• According to Prof. GautamMathur, deficit financing can be used tofinance government projects.• Investment is of two types:– A) Inflation Creating Activities: such aslong gestation projects in Heavysector, etc.– B) Inflation Dampening Activities: such asin agriculture, food industries, etc, whichhave shorter period of production.Prabha Panth
  17. 17. 17• Investment in Inflation Creating andInflation Dampening Activities should bemade equal• This is called “Balanced AllocationRatio.”• Then inflation can be prevented• Economic development can take place• As both industrial and agriculturalgrowth is encouraged.- - - - -Prabha Panth