Fiscal policy is the deliberate change in government spending and taxes to stimulate or slow down the economy. In the words of F. R. Glahe “By fiscal policy is meant the regulation of the level of government expenditure and taxation to achieve full employment without inflation in the economy.” J. M. Keynes describes fiscal policy as the stearing wheel for the aggregate economy.
Main objectives of Fiscal Policy:
The objectives of fiscal policy differ with the state of development in the country. In advanced countries of the world, the goal of fiscal policy may be the maintenance of full employment without inflation. In developing countries the objectives of fiscal policy may be to achieve maximum level of employment and reduction economic inequalities. However the main objectives of fiscal policy are in brief as under.
1. Removing deflationary gap: J. M. Keynes is of the view that fiscal policy can play a major role in lifting the economy out of depression and closing the deflationary gap. When the economy is a depression, it is faced with rising unemployment falling income, severe declining investment and shrinking of economic activities. The government by undertaking public works programme increases its expenditure which helps in raising the level of aggregate demand of employment in the economy. The government can also induce changes in aggregate investment by reduction of taxes, tax, relieves, abolition of sales tax, reducing excise duties etc. The tax relief measures are also an effective method to raise the level of aggregate demand and removing deflationary gap from the economy.
2) Fiscal policy in Inflation: If the economy of a country is faced with inflationary gap, then anti-cyclical fiscal policies should be adopted to bring down the prices and for closing the inflationary gaps. The main fiscal measures to bring down the excess demand in the economy are (i) Reduction in government expenditure (ii) Increase in taxes and (iii) Creating a budget surplus. By adopting contractionary fiscal policy, the aggregated demand curve shifts downward, and the economy begins to operate at the desired potential level of income.
3) Counter Cyclical fiscal policy: Another important objective of fiscal policy is to minimize the fluctuations in aggregate demand so that the economy is always at its target and potential level of income. The fluctuations in the economy which are associated with the business cycles can be smoothed in a number of ways. For example when the aggregate demand rises rapidly in the expansionary phase of the business cycle, it can be tuned by reducing government expenditure or raising taxes. This will help in dampening down the expansionary phase. In the recessionary phase the problem of unemployment and low growth can be covered and remedied by cutting taxes and raising government expenditure. If timely counter cyclical fiscal measure is adopted the problems of excess or deficiency of demand will never be severe and economy operates at the potential level of income which is called fine tuning.
4) Equilibrium in balance of payment: The level of national income is also affected by the balance of payments position of the country. If the country has a favourable balance of payments it will lead to increase in income. This rise in aggregate demand will shift the demand line upward and will increase the level of national income. The all in the balance of payments has effect. The government uses fiscal policy in such a way that the balance of payments remains in equilibrium in the short run.
5) Economic Growth: The elements of Keynes fiscal policy were developed in 1930’s. Since then, the Keynesian fiscal policy is in action. The economists believe even now that if the economy is operating below its potential level, the increase in government expenditure and cut in taxes is the perfect medicine to bring the economy back to its full employment level. The economist’s stress that government should encourage investment to increase the rate of capital formation by using timely proper fiscal measures. The government borrowing for financing schemes of development, the increase in ratio of savings to national income, cut in taxes to increase investment spending can accelerate the rate of capital for nation in the country and lead to economic growth.
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