Monday, August 24, 2009

Fiscal Policy

Principal instrument of fiscal policy is the public finance or budget. It involves purposeful manipulation of public expenditure, taxation and public debt. This is known as functional finance, Public expenditure, taxation and public borrowing have to gear to fight inflationary and deflationary tendencies so that the national economy moves on an even keel.

Among the broad aims of fiscal policy are:

(i) To improve the efficiency of productive capacity of the economic system by an optimum allocation of the productive resources in men, money and minerals. These productive resources are so allocated and utilised that they make a maximum contribution to national output, income and employment.

(ii) The fiscal policy aims not only at maximising national income and output but to bring about an equitable distribution there of. It seeks to reduce inequalities of income and wealth in order to promote general welfare of the community.

(iii) The over riding objective of fiscal policy is to increase employment opportunities in the country and to make the economy march towards full employment. Public expenditure, taxation and borrowing policies are aimed at increasing consumption, saving and investment. Unnecessary or conspicuous consumption is to be ruthlessly curtailed and mass consumption which creates employment should be stimulated by means of suitable taxation and by giving suitable direction to public expenditure. But side by side all possible incentives should be provided for saving and even consumption may be resorted to so that the incomes are not recklessly squandered. On the other hand, sizeable proportion of incomes should be saved towards into productive investment. For this purpose necessary mechanism must be provided like a sound capital market and healthy stock exchanges. Thus both taxation and public expenditure should be geared to economic growth and development.

(iv) To maintain economic stability and price stability is another important objective of fiscal policy. It must be so designed as to maintain a reasonably stable price level and to eliminate cyclical fluctuation. A suitable fiscal policy has to be formulated for an inflationary situation and for depression.

During depression there is wide-spread unemployment and fiscal policy must not only, remove this unemployment but generate additional employment. The government should adopt a taxation policy which encourages private consumption and investment. Taxes are reduced to provide incentives for investment; public expenditure is increased through budget deficits which are financed by borrowing from the public commercial banks and the central bank of the country. During depression government spending assumes a great importance. It seeks to lift the economy out of the morass of stagnation. Public expenditure revives economic activity and compensatory spending by government is intended to make up the deficiency of private investment. Government increases its expenditure on public works and there are transfer payments like subsidies and relief payment. Massive deficit-financed spending can almost surely put millions back to work and push the economy back to reasonably high level of employment.

During the inflation, however the fiscal policy has to be different. Through taxation and borrowing the government must withdraw money from the income stream so that purchasing power is taken away from the public. This will exercise deflationary pressure and tend to bring down prices. But the crucial thing is that the withdrawal of money from the income stream should not be replaced by Government spending.

Thus fiscal policy should remove both inflationary and deflationary pressures and make the working of the economy smooth and steady.

To sum up, fiscal policy can serve as a powerful instrument in taking the economy to the goal of full employment, by mobilising productive resources and their optimum utilisation increasing government expenditure and investment to cover the gap between income and consumption by relating consumption function, by encouraging private investment, by maintaining economic stability, by promoting capital formation and by suitably altering distribution of income.


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