Fiscal Policy

By

Kumar Devrat

Rohita

Mohit Shukla

Nasreen

Prashant Sharma

What is Fiscal Policy?

• Fiscal policy involves the Government changing the levels of Taxation and Govt Spending in order to influence Aggregate Demand (AD) and therefore the level of economic activity.

• AD is the total level of planned expenditure in an economy

• C-  is consumption  ,•  I- is Investment,• G-  is Government spending,

 •  X- is total exports, and•  M- is total imports

AD = C+ I + G + X – M

Reasons for Fiscal deficitIncrease in Subsidies

Payment of Interest

Defense Expenditure

Poor Performance of Public Sector

Tax Evasion

Weak Revenue Mobilization

Huge Borrowings

Unproductive expenditure by the

government

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Objectives Of Fiscal Policies

Achieve desirable price level

Achieve desirable consumption level

Achieve desirable employment level

Achieve desirable income distribution

Increase in capital formation

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Types Of Fiscal policies

Expansionary Fiscal Policy

Contractionary Fiscal Policy

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Expansionary Policy / Loose

Involves increasing AD

This will worsen the govt budget deficit

Govt will increase spending (G) & Cut Taxes

Lower taxes will increase consumers spending because they have more

disposable income(C)

Risk of High Inflation due to huge demand & increase in money supply

AD = C+ I + G

+ X – M

Contractionary Policy / Tight

Involves decreasing AD

This will help in improving the govt budget deficit

Govt will cut spending (G) & Increase Taxes

High taxes will decrease consumers spending because they have less

disposable income(C)

Not Easy to achieve this

AD = C+ I + G + X – M

Balancing Economy

Automatic Fiscal Stabilizer

Discretionary  Fiscal Policy

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Tools Of Fiscal Policies

Government Borrowings

Income Of The Government

Public

Expenditure

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Fiscal Responsibility And Budget Management (FRBM)

FRBM

•Long-term macroeconomic stability

FRBM

•Reducing revenue deficit

FRBM

•Reducing the Public debt

FRBM

•No Borrowing from the RBI

Criticisms of Fiscal Policy

Disincentives of Tax Cuts.

Crowding out

Time lags

Poor Informati

on

Implications of Fiscal policy• It will lead to capital infrastructure like higher education,

growth and output.• It help and facilitate trade and promote economic activity in

the private sector.• It will build up the framework for strong economic growth and

working towards full employment.• It will improve and promote in economic development.

IS-LM Curve

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Cont..

• An increased deficit by the national government shifts the IS curve to the right.• This raises the equilibrium interest rate (from i1 to i2)

and national income (from Y1 to Y2), as shown in the graph.• The equilibrium level of national income in the IS-LM

diagram is referred to as aggregate demand.• The graph indicates one of the major criticisms of deficit

spending as a way to stimulate the economy: rising interest rates lead to discouragement – of private fixed investment, which in turn may hurt long-term growth of the supply side

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AS-AD Framework

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AD0

AD1

••

AS

Y0

Price level

Real GDPY1

P0

P1

Government’s Income• Direct and Indirect Tax• Progressive Tax and Regressive Tax• Non Tax Revenue 

• Administrative receipts• Net contribution of• Public sector undertaking• Railways• Posts and Telegraphs• Currency and mint• Other

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Public Debt

• The government can turn to the capital markets to borrow the necessary money.• Borrowings could be from the Reserve Bank of India

(RBI), from the public by floating bonds, financial institutions, banks and even foreign institutions.• Borrowing from capital market is done primarily by

issuing securities, either Treasury Bills or Treasury Bonds

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Public Expenditure• Public expenditure is incurred in the form of purchases of goods and

services, transfer payments and lending.• Divided under two heads i.e. Plan Expenditure and Non Plan

expenditure.• The plan expenditure is developmental in nature. Plan expenditure refers

to the expenditure incurred by the Central Government on Programs/Projects, which are recommended by the Planning Commission.

• According to the ministry of finance non-Plan expenditure is a generic term, which is used to cover all expenditure of Government not included in the Plan expenditure. It includes both developmental and non-developmental expenditure. Part of the expenditure is obligatory in nature e.g. interest payments, pensionary charges and statutory transfers to States. A part of the expenditure is an essential obligation of a State, e.g. Defense and internal security. Expenditure on maintaining the assets created in previous Plans is also treated as Non-plan expenditure.

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Thank You !