Name-Eeshan Dande Roll Number-13
Macroeconomics
Internal Assessment -3 on
Fiscal Policy
The economy cannot always work and function smoothly. There are often deviations and
fluctuations in an economy. At times the economy can be experiencing Inflation or a boom
phase and at times it can come under the grip of deflation or also Recession. During
Recession the economy functions far below its optimum levels. There is a lot of excess
capacity. There are lot of factories having heavy machinery which are at idle output. This a
result of high unemployment and excess unutilized capital stock.
During the early 20 th century especially during the Great Depression of 1930’s and later the
world war II capitalist western economies such as the US, Great Britain, Canada and France
faced severe economic calamities and went into digressionary state. According to classical
economists’ automatic mechanism would start working to correct the economic situation and
bring in stability. However, no such thing was witnessed and the Great Depression extended
for almost 10 years from 1929-1939. After the World War II was over and worldwide
economies were left in distress John Maynard Keynes a British Economist argued through his
work that government intervention is a must to cure depression and inflation by adopting
appropriate tools of macroeconomic policy.
The two important policies devised were the Fiscal and monetary policy. Keynes
emphasized on the role of fiscal policy more than monetary. Fiscal policy is a means by
which a government adjusts its spending and tax rates to monitor, scan and influence a
country’s economy. This policy states that governments can influence macroeconomic
productivity by either increasing or decreasing their Government revenue through increase or
a decrease in taxes and also decide and adjust the public spending (government expenditure)
on social welfare and other government-oriented schemes. Hence fiscal policy can be
implemented accordingly in the inflationary and recessionary period.
The implementation of scenario based fiscal policy have certain primary objectives. They can
differ based on economy to economy and government to government. The most important
ones include:
1) Price stability
2) Economic growth
3) Higher level of output and employment
4) Accelerate the level of capital formation through encouraging investments from
private sector as well.
Higher output and push in aggregate demand curve towards the right has a resultant effect on
increase in employment which results in more available job slots. Economies with lower
employment must initiate policies towards increasing output to increase employment. On the
other hand, inflation must be controlled and fiscal policy places an important role in
achieving and maintaining price stability in the economy. If there is a steep increase in prices
it can cause hyperinflation especially in underdeveloped economies such as Zimbabwe and
developing economies such as Iran. Encouraging investment helps in creating jobs and
improving on the rate of unemployment. Example through and Indian lens can be the Make
in India campaign initiated by the current BJP government in the area of secondary or
, Name-Eeshan Dande Roll Number-13
manufacturing industry which aims at making India a producer driven based economy for
technology, defense, chemicals, automotive sector etc.
To understand how fiscal policy works it’s important to understand the instruments of Fiscal
Policy.
1) Public revenue: can be divided into two parts tax and non-tax which stem from
Household and Business. Tax includes Direct tax such as Income tax and corporate tax, as
well as indirect tax which comprises of GST (goods and service), custom duties etc. This
instrument is important for changing the disposable income, consumption pattern and
investment.
2) Public expenditure: consists of two types planned and non-planned expenditure. Planned
expenditure consist of expenditure oriented in a planned order.E.g. - planning commissions or
State and Union Territory plans. They have preset spending budgets on various projects in
the coming future. Non-planned expenditure is general expenditure which can change
immediately based on needs of the government. For e.g.- spending on transfer payments,
social security, aid etc. Appropriate variation in govt expenditure can have more direct effect
on the economy than even government revenue. Change in effect of government expenditure
will have a multiple effect on income, output and employment. Decrease in government
expenditure will reduce the level of economic activity and reverse govt expenditure
multiplier would be seen working. Keynes general theory highlights public works as the most
efficient anti-depression device. Public works consist of spending of government on massive
projects such as roads, parks, post office, schools, dams etc. expenditure can have further two
forms, capital expenditure and current expenditure. Capital expenditure happens on building
of capital assets such as heavy machinery, airports, hospitals etc. Current expenditure
happens on current expenses such as transfer payments, subsides etc.
3) Public Debt: it is the difference between the government receipts and spending in one
year. Government borrowing under public debt can be in a) Borrowing from non-bank public,
b) borrow from banking institutions, c) printing of money. Borrowing from non-bank public
is done through sale of bonds. Money used for consumption may flow out to saving or
investment. If bond selling scheme of the government is attractive then the consumption gets
curtailed. This kind of borrowing is non-inflationary as public. Will buy bonds and reduce
consumption. Had the government not borrowed these funds it may have been used for
private investment. b) borrowing from banking institutions during recession are effective.
Banks have excess cash reserves as the private community is unwilling to borrow from
banks. When this cash comes to utilization it results in addition to circular flow and increases
employment. Therefore, it is helpful in a state of depression. When borrowed money is spent
on public works. This works vice versa during inflation. Banks do not possess excess cash to
lend. It becomes difficult to lend cash to the government hence borrowing from bank is
desirable during depression and undesirable during inflation.
4) Printing of money- also called as deficit financing is another method of public
expenditure. It results to a net add in the circular flow. This form of public borrowing is
highly inflationary and hence government needs to be careful in supplying money. Its desired
during deflationary period as it helps income level to rise as well as employment. It can
create easy money supply and lower interest rates as plentiful is available by business and
individuals for loans.
Macroeconomics
Internal Assessment -3 on
Fiscal Policy
The economy cannot always work and function smoothly. There are often deviations and
fluctuations in an economy. At times the economy can be experiencing Inflation or a boom
phase and at times it can come under the grip of deflation or also Recession. During
Recession the economy functions far below its optimum levels. There is a lot of excess
capacity. There are lot of factories having heavy machinery which are at idle output. This a
result of high unemployment and excess unutilized capital stock.
During the early 20 th century especially during the Great Depression of 1930’s and later the
world war II capitalist western economies such as the US, Great Britain, Canada and France
faced severe economic calamities and went into digressionary state. According to classical
economists’ automatic mechanism would start working to correct the economic situation and
bring in stability. However, no such thing was witnessed and the Great Depression extended
for almost 10 years from 1929-1939. After the World War II was over and worldwide
economies were left in distress John Maynard Keynes a British Economist argued through his
work that government intervention is a must to cure depression and inflation by adopting
appropriate tools of macroeconomic policy.
The two important policies devised were the Fiscal and monetary policy. Keynes
emphasized on the role of fiscal policy more than monetary. Fiscal policy is a means by
which a government adjusts its spending and tax rates to monitor, scan and influence a
country’s economy. This policy states that governments can influence macroeconomic
productivity by either increasing or decreasing their Government revenue through increase or
a decrease in taxes and also decide and adjust the public spending (government expenditure)
on social welfare and other government-oriented schemes. Hence fiscal policy can be
implemented accordingly in the inflationary and recessionary period.
The implementation of scenario based fiscal policy have certain primary objectives. They can
differ based on economy to economy and government to government. The most important
ones include:
1) Price stability
2) Economic growth
3) Higher level of output and employment
4) Accelerate the level of capital formation through encouraging investments from
private sector as well.
Higher output and push in aggregate demand curve towards the right has a resultant effect on
increase in employment which results in more available job slots. Economies with lower
employment must initiate policies towards increasing output to increase employment. On the
other hand, inflation must be controlled and fiscal policy places an important role in
achieving and maintaining price stability in the economy. If there is a steep increase in prices
it can cause hyperinflation especially in underdeveloped economies such as Zimbabwe and
developing economies such as Iran. Encouraging investment helps in creating jobs and
improving on the rate of unemployment. Example through and Indian lens can be the Make
in India campaign initiated by the current BJP government in the area of secondary or
, Name-Eeshan Dande Roll Number-13
manufacturing industry which aims at making India a producer driven based economy for
technology, defense, chemicals, automotive sector etc.
To understand how fiscal policy works it’s important to understand the instruments of Fiscal
Policy.
1) Public revenue: can be divided into two parts tax and non-tax which stem from
Household and Business. Tax includes Direct tax such as Income tax and corporate tax, as
well as indirect tax which comprises of GST (goods and service), custom duties etc. This
instrument is important for changing the disposable income, consumption pattern and
investment.
2) Public expenditure: consists of two types planned and non-planned expenditure. Planned
expenditure consist of expenditure oriented in a planned order.E.g. - planning commissions or
State and Union Territory plans. They have preset spending budgets on various projects in
the coming future. Non-planned expenditure is general expenditure which can change
immediately based on needs of the government. For e.g.- spending on transfer payments,
social security, aid etc. Appropriate variation in govt expenditure can have more direct effect
on the economy than even government revenue. Change in effect of government expenditure
will have a multiple effect on income, output and employment. Decrease in government
expenditure will reduce the level of economic activity and reverse govt expenditure
multiplier would be seen working. Keynes general theory highlights public works as the most
efficient anti-depression device. Public works consist of spending of government on massive
projects such as roads, parks, post office, schools, dams etc. expenditure can have further two
forms, capital expenditure and current expenditure. Capital expenditure happens on building
of capital assets such as heavy machinery, airports, hospitals etc. Current expenditure
happens on current expenses such as transfer payments, subsides etc.
3) Public Debt: it is the difference between the government receipts and spending in one
year. Government borrowing under public debt can be in a) Borrowing from non-bank public,
b) borrow from banking institutions, c) printing of money. Borrowing from non-bank public
is done through sale of bonds. Money used for consumption may flow out to saving or
investment. If bond selling scheme of the government is attractive then the consumption gets
curtailed. This kind of borrowing is non-inflationary as public. Will buy bonds and reduce
consumption. Had the government not borrowed these funds it may have been used for
private investment. b) borrowing from banking institutions during recession are effective.
Banks have excess cash reserves as the private community is unwilling to borrow from
banks. When this cash comes to utilization it results in addition to circular flow and increases
employment. Therefore, it is helpful in a state of depression. When borrowed money is spent
on public works. This works vice versa during inflation. Banks do not possess excess cash to
lend. It becomes difficult to lend cash to the government hence borrowing from bank is
desirable during depression and undesirable during inflation.
4) Printing of money- also called as deficit financing is another method of public
expenditure. It results to a net add in the circular flow. This form of public borrowing is
highly inflationary and hence government needs to be careful in supplying money. Its desired
during deflationary period as it helps income level to rise as well as employment. It can
create easy money supply and lower interest rates as plentiful is available by business and
individuals for loans.
