3. FISCAL POLICY:-
Fiscal policy is defined as the policy under which the
government uses the instrument of taxation, public spending, and
public borrowing to achieve various objectives of economic
policy. Simply put, it is the policy of government spending and
taxation to achieve sustainable growth. Fiscal policy is often
contrasted with monetary policy which is regulated by the
central bank. It is largely inspired by the ideas of British
economist John Maynard Keynes whose theories were developed in
the response to the Great Depression and were hugely influential
in the formulation of the New Deal in the U.S. that aimed at
huge spending for public projects and social welfare
development.
4. HOW DOES IT WORKS?
When policymakers want to influence the economy, they mainly
have two tools at their disposal, Monetary policy and Fiscal
policy. The monetary policy is regulated by the central
banks. Money supply in the market is adjusted by tweaking the
interest rates, bank reserve rates, sale and purchase of
government securities, and foreign exchange.
On the other hand, fiscal policy is influenced by the
governments by adjusting the nature and extent of the taxes,
government spending, and borrowing. A healthy fiscal policy
is important to control inflation, increase employment, and
maintain the value of money. It has a very important role in
managing the economy.
5. TYPES OF FISCAL POLICY
There are three types of Fiscal policy
1. Neutral Policy
2. Contractionary Policy
3. Expansionary Policy
6. Neutral Policy
Fiscal neutrality refers to a situation where neither the government's public expenditure
nor the tax policy affects the demand in an economy. The consumer demand is not
influenced by the tax laws or the government's welfare programs.
7. Contractionary Policy
Contractionary fiscal policy is said to be in action when the government reduces
spending and increases taxes at the same time in the country. The result of such a move
is that there is very little money available in the market. It leads to a reduction in
purchasing power which results in declining consumption.
8. Expansionary Policy
Contractionary fiscal policy is said to be in action when the government reduces
spending and increases taxes at the same time in the country. The result of such a move
is that there is very little money available in the market. It leads to a reduction in
purchasing power which results in declining consumption.
9. Objectives of Fiscal Policy
1. To promote Economic Growth
2. To reduce income and wealth inequalities
3. To provide employment opportunities
4. To ensure stability in prices
5. To correct balance and payment deficit
6. To provide for effective administration
10. What Are the Tools of Fiscal Policy?
A government uses fiscal policy to achieve the macroeconomic goals of price stability and total employment
output to have a stable, growing economy. Over time a nation's economy fluctuates and can be in one of
three states:
•Recessionary gap: A recessionary gap is when the economy is struggling, experiencing price level deflation,
production of goods and services below its potential output, and high unemployment.
•Full employment output: Full employment output, also called potential output, represents a healthy economy
producing at its expected potential given its resources and population.
• It is important not to confuse full-employment output and everyone being employed. Instead, it means it is a
minimum level of unemployment that is sustainable.
•Inflationary gap: An inflationary gap is when the economy is overheated, producing at an unsustainable level
and causing inflation.
11. Government Spending
Government spending is one fiscal policy tool and occurs when the government spends money
purchasing goods and services, affecting aggregate demand for those goods and services. When
output to meet the new level of demand and prices. The opposite is true when aggregate demand is
how government spending can influence the economy:
The United States is in a recessionary gap; one way to fix this gap would be by increasing spending.
spend more on fixing the country's infrastructure by improving highways and replacing lead pipes.
First, the government would have to purchase the necessary resources to complete those projects,
new pipes. The new need for these resources increases aggregate demand in the economy. Output
needs, and so does price because firms can now charge more since their products are in higher
firms producing copper and other materials need to hire more employees to match the new
need to hire contractors to do the roadwork and replace the pipes.
12. Taxes
Government spending is one fiscal policy tool and occurs when the
government spends money purchasing goods and services,
for those goods and services. When aggregate demand goes up, so
the new level of demand and prices. The opposite is true when
decreased. Below is an example of how government spending can
The United States is in a recessionary gap; one way to fix this gap
spending. To do this, congress decides to spend more on fixing the
by improving highways and replacing lead pipes.
First, the government would have to purchase the necessary
projects, such as the copper needed for the new pipes. The new
increases aggregate demand in the economy. Output goes up to
needs, and so does price because firms can now charge more since
higher demand. Employment rises because firms producing copper
need to hire more employees to match the new demand.
need to hire contractors to do the roadwork and replace the pipes.
13. Transfer Payment
Transfer payments are when the government spends money to benefit its
citizens but receives no goods or services in return, differentiating it from
example of transfer payments affecting the economy is if the government
program. Suppose more people are eligible to receive welfare under this
spending will increase because those new people who now receive welfare can
previously did not have. This expansion would help in a recessionary economy
spending increases aggregate demand.
