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What is Fiscal Policy?

by Puja

Fiscal Policy refers to the methods employed by the government to influence and monitor the economy by adjusting taxes and/or public spending. In addition, the government aims to find a balance between lowering unemployment and reducing the inflation rate. Similarly the main tools of Fiscal Policy are changes in the composition of taxation and government spending.


 “A policy under which the government uses its outlay and revenue programmes to produce desirable effects and avoid undesirable effects on the national earnings, manufacturing and employment.”

Objectives of fiscal policy

1. Firstly, to uphold and accomplish full employment.

2. Secondly, to alleviate the price level.

3. To soothe the development rate of financial system.

4. To sustain symmetry in the balance of payment.

5. To endorse the monetary development of under developed nations.

Instruments of Fiscal Policy

Following are the main instruments of fiscal policy

1. Public Expenditure

Public Expenditure means expenditure incurred by the government of a country. Meanwhile it generates sufficient influence on aggregate demand and development activities of a country. The expenditure can be of two types:

  • Firstly, expenditure incurred by the government to get goods and services. It directly influences aggregate demand.
  • Secondly, public expenditure incurred on pensions, scholarships, educational and medical facilities to people etc. Moreover, It also raises aggregate demand.

2. Modern states are welfare oriented states and they have to use money to achieve this end. Tax is the main source to acquire money. Aggregate demand can also be influenced by taxes. Hence, government collects money by imposing different taxes to finance public expenditure and to manage various development activities. Mainly, taxes can be classified into two groups

  • Direct Tax: Firstly, direct tax reduces the income of the people and a part of their income goes into the government treasury.
  •  Indirect Tax: Secondly, indirect taxes lead to a rise in prices of goods.
3. Public Debt –

The third instrument of fiscal policy is public debt. Public debt means debt taken by the government from people or from the governments of other countries. Meanwhile, the government has to take the help of public debt if public expenditure exceeds public revenue. Public debt can be of two types: Internal and External.

4. Deficit Financing

A public expenditure has to be incurred for economic development. This amount collected only through the public debt, taxation etc. Therefore deficit financing has introduced.

However, when there emerges a deficit due to excess of public expenditure over public revenue, this deficit is met with either by borrowing from the central bank or by issuing new notes. Therefore, deficit financing can be used to meet government expenditure. It increases aggregate demand.

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