Fiscal Policy

Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy.
It is a complementary strategy to monetary policy (which involves a central bank influencing money supply).
Deals with taxation, borrowing, and expenditure decisions of the government.
An important constituent of the overall economic framework and general economic policy strategy of a country.

Instrument of Development: Reliance on fiscal policy for development, as stated by the Planning Commission (Seventh Five Year Plan).
Provision of Public Services & Public Investment: Government creates and sustains the public economy.
Resource Reallocation: Instrument for reallocation of resources according to national priorities.
Redistribution of Income & Wealth: Promotes private savings and investments.
Economic Growth with Price Stability: Primary aim.
Capital Formation, Resource Allocation, Redistribution for Mitigating Inequality: Key goals.
In developed countries, fiscal policy focuses on tackling business cycles (boom-bust).
In developing countries, fiscal policy prioritizes high economic growth, increased savings, investments, and judicious allocation of scarce capital and resources for development.

Defined as an increase in government expenditures and/or a decrease in taxes.
Causes the government's budget deficit to increase or its budget surplus to decrease.
Methods:

Purpose: To stimulate economic growth during a recession or slowdown, increase aggregate demand, create jobs.

Defined as a decrease in government expenditures and/or an increase in taxes.
Causes the government's budget deficit to decrease or its budget surplus to increase.
Purpose: To cool down an overheated economy, control inflation, reduce budget deficits.

Government Expenditure:
- Revenue Expenditure: Day-to-day running of government (salaries, subsidies, interest payments).
- Capital Expenditure: Creation of assets (infrastructure, defence equipment). Boosts productive capacity.
Taxation:
- Direct Taxes: Income tax, corporate tax, property tax (burden cannot be shifted). Progressive in nature.
- Indirect Taxes: GST, customs duties (burden can be shifted). Regressive in nature.
Public Debt:
- Internal Debt: Borrowing from domestic sources (e.g., individuals, banks).
- External Debt: Borrowing from foreign sources (e.g., international organizations, foreign governments).
- Used to finance budget deficits or fund development projects.
Budget (Government Budget): An annual financial statement showing estimated receipts and expenditures of the government for a fiscal year. Reflects fiscal policy stance.

Neutral Fiscal Policy: When the budget is balanced, implying no significant impact on economic activity.
Expansionary (or Loose) Fiscal Policy: When government spending exceeds tax revenue (deficit budget). Aims to stimulate economy.
Contractionary (or Tight) Fiscal Policy: When tax revenue exceeds government spending (surplus budget). Aims to curb inflation or reduce debt.

Fiscal Policy: Controlled by the Government (Ministry of Finance). Deals with government spending and taxation. Direct impact on aggregate demand.
Monetary Policy: Controlled by the Central Bank (RBI in India). Deals with money supply, credit availability, interest rates. Indirect impact on aggregate demand.
Often used in coordination for overall economic stability.

Time Lags: Recognition lag, decision lag, implementation lag, impact lag.
Crowding Out: Government borrowing to finance deficits can increase interest rates, reducing private investment.
Political Economy Issues: Difficult to implement unpopular measures like tax hikes or spending cuts.
Fiscal Deficit Management: Balancing the need for growth with fiscal prudence.
Inflationary Pressures: Excessive expansionary policy can lead to inflation.