Fiscal Policy - Meanings, Objectives, Types | Detailed Review

INTRODUCTION: FISCAL POLICY

The macroeconomics perspective, the focus is on the aggregate economic activity of governments, say, aggregate expenditure taxes, transfers and issues of government debts and deficits and their effects on aggregate economic variables such as aggregate output, aggregate employment, inflation, global economic growth etc. These, in case, form the subject material of fiscal policy.

The connotation of fiscal policy as a strategy for achieving certain socio economic purpose was not perceived or widely acknowledged before 1930 due to the faith in the fixed role of government advocated by the then prevailing laissez-faire approach. Great Depression and the consequent instabilities made policymakers support a more proactive role for governments in the economy. However, later on, markets fail to achieve optimal outcomes and the need for government intervention to combat those market failures. In latest times, especially after being portended by the global financial crisis and recession, many countries have adopted to have a more active fiscal policy.

Governments of all countries pursue innumerable policies to accomplish their economic goals such as rapid economic growth, equitable distribution of wealth and income, reduction of poverty, price stability, exchange rate stability, full-employment, balanced regional development etc. Government budget is one among the most powerful instruments of economic policy. The influential engine in the budgetary policy could be broadly segregated into public revenue along with taxation, public expenditure, public debt and finally deficit financing to traverse the gap between public receipts and payments. When all these means are used for achieving goals of economic policy, public finance is converted into what is called fiscal policy. 

Fiscal policy engages the use of government spending, taxation and borrowing to influence both the figure of economic activity and elevation of growth of aggregate demand, output and employment. It covers and formed on the part of the government to change the price level, content or timing of government expenditure or to transform the burden, structure or constancy of tax payment. In other words fiscal policy is formed to influence the figure and level of economic activity in a country. Fiscal policy is in the nature of demand side policy. An economy which is contributing at full-employment level does not require government force in the form of fiscal policy.

OBJECTIVES OF FISCAL POLICY

The objectives of fiscal policy, like those of other economic policies of the government are derived from the aspiration and goals of the society. Since nations defer in numerous aspect, the objectives of fiscal policy are:

• Achievement and maintenance of full employment,
• Maintenance of price stability,
• Acceleration of the rate of economic development, and
• Equitable distribution of income and wealth,

The attention as well as order of precedence of these objectives may vary from country to country and from time to time. For occurrence, while stability and equality may be the preferences of developed nations, economic growth, employment and equity may get higher preeminence in developing countries. Also, these aspirations are not always compatible; the objective of achieving decent distribution of income may conflict with the objective of economic growth and efficiency.

TYPES OF FISCAL POLICY

1. Expansionary Fiscal Policy
2. Contractionary Fiscal Policy

(1). Expansionary Fiscal Policy

An expansionary fiscal policy is used to address recession and the problem of general unemployment on account of business cycles. We may technically refer to this as a policy major to close a 'recessionary gap'.A recessionary gap, also known as contractionary gap, is said to exist if the existing levels of overall production is less than what would be originated with full employment of resources. It is a measure of output that is lost when actual national income falls short of potential income, and represents the difference between the actual aggregate demand and the aggregate demand which is required to establish the equilibrium at full level of income. This gap occurs during the contrationary face of business-cycle and results in higher rates of unemployment. In other words, recessionary gap occurs when the aggregate demand is not sufficient to create conditions of full employment.

It may however we noted that expansionary fiscal policy will be successful only if there is accommodative monetary policy. If interest rates increases as a result of increased demand for money but money supply does not rise simultaneously, then private investment will be skeptically affected. If interest rates remain unchanged, private investment will not be affected badly and a rise in government expenditure will have full effect on nation income and employment. 

 

(2). Contractionary Fiscal Policy

Contractionary fiscal policy is subjected to the premeditated policy of government applied to curtail overall demand and consequently the level of economic activity. In other words, it is fiscal policy aimed at eliminating an inflationary gab. This is achieved by adopting policy measures that would result in the aggregate demand curve (AD) shift to the left equilibrium may be established at the full employment level of real GDP. This can be achieved either by:

1. Curtail in government spending: with restrain in government spending the aggregate amount of money available in the economy is compressed which in turn prune down the aggregate demand.
2. Increase in personal income taxes and/or business taxes: an increase in persona;l income taxes reduces disposable incomes leading to fall in consumption spending and aggregate demand. An increase in taxes on business profits reduces the oversupplies available to businesses, and as a result, firms investments shorten causing aggregate demand to fall. Heightened taxes also dampen the anticipations of profits of potential newcomers who will respond by holding back fresh investments.
3. A combination of decrease in government spending and increase personal income taxes and/or business taxes.

Conclusion: When aggregate demand rises beyond what the economy can potentially produced by fully employing it's given resources, it gives rise to inflationary pressures in the economy. The overall demand may increase due to large increase in consumption demand by households or investment expenditure by entrepreneurs, or ministry/union/authority expenditures. In these substance inflationary gap occurs which tends to bring about rise in the level of prices. Under such precedence, a contractionary fiscal policy will have to be used.