Fiscal Policy

Fiscal Policy

Economics can be broadly classified as Microeconomics and Macroeconomics. These have different objectives that are required to be achieved; the instruments for achieving these objectives, i.e., policies can be classified as fiscal, monetary, income, and foreign exchange. The first points to the operation of the government treasury, its two major elements being public expenditure and taxation.

The second points to the total supply of money in the economy. The supply of currency jointly with bank deposits has a direct effect on rates of interest investment, and in turn, on the total output, besides influencing the level of employment and prices. The third aims at controlling prices, thus fixing the way national income is shared by various groups of the society.

These policies also produce effects on employment and economic growth. The fourth one works through licensing, quotas, import duties, export bounties, etc., thus determining the exchange rate and maintaining steadiness. All these policies aim at carrying desired changes in foreign trade and payments on foreign accounts.

Objectives of Fiscal Policy

Its role in developed economies is to maintain full employment and stabilize growth. In contrast, in developing countries, it is used to create an environment for rapid economic growth. The various aspects of this are:

Mobilization of Resources
Developing economies are characterized by low levels of income and investment, which are linked in a vicious circle. This can be successfully broken by mobilizing resources for investment energetically.

Acceleration of Economic Growth
The government not only has to mobilize more resources for investment but also direct the resources to those channels, where the yield is higher and the goods produced are socially acceptable.

Minimization of the Inequalities of Income and Wealth
Fiscal tools can be used to bring about the redistribution of income in favor of the poor by spending revenue so raised on social welfare activities.

Increasing Employment Opportunities
Financial incentives, in the form of tax-rebates and concessions, can be used to promote the growth of those industries that have high employment-generation potential.

Price Stability
Fiscal tools can be employed to contain inflationary and deflationary tendencies in the economy.


It has been a great success in developed countries, but only partially so in developing countries. The tax structure in the developing countries is rigid and narrow. Thus, conditions conducive to the growth of well-knit and integrated tax policies are absent and sorely missed. Following are some of the reasons that are hindrances for its implementation in developing countries:

  • A sizable portion of most developing economies is non-monetized, rendering fiscal measures of the government ineffective and self-defeating.
  • Lack of statistical information with regards to the income, expenditure, savings, investment, employment, etc., makes it difficult for the public authorities to formulate a rational and effective fiscal policy.
  • It cannot succeed unless people understand its implications and cooperate with the government in its implication. This is because, in developing countries, majority of the people are illiterate.
  • Large-scale tax evasion by people, who are not conscious of their roles in the development, has an impact on the policy.
  • It requires efficient administrative machinery to be successful. Most developing economies have corrupt and inefficient administrations that fail to implement the requisite measures vis-à-vis the implementation of this policy.

Among the various tools of fiscal policy, following are the most important ones:

It may be used to boost the level of economic activity during periods of recession or deceleration in economic activity. This is done by lowering taxes or increasing government expenditure.

During the boom, i.e., when the economy is growing beyond its capacity, inflation and balance of payment problems might result. This can be achieved by increasing taxes or by reducing government expenditure.

It would perhaps be too simplistic to conclude that fiscal policy is the most important tool of financial correction and consolidation, especially that undertaken by the government. However, there is no reason to neglect this very powerful tool that is in the hands of governments and central banks all over the world. If used properly, it can determine the broad direction the economy of a given country is going to take.