Wednesday, May 18, 2011

What are the basic objectives of a fiscal policy?

What are the basic objectives of a fiscal policy?
Analyze the objectives given in Table 21.1 (Unit-21, Block-5) and put
forward your arguments as to:
i) Whether they are conflicting or not? Explain how?
ii) Which ones should be given greater priority in a developing country?

Answer. Fiscal policy is the economic term that defines the set of principles and
decisions of a government in setting the level of public expenditure and how that
expenditure is funded. Fiscal policy and monetary policy are the macroeconomic
tools that governments have at their disposal to manage the economy. Fiscal
policy is the deliberate and thought out change in government spending,
government borrowing or taxes to stimulate or slow down the economy. It
contrasts with monetary policy, which describes policies concerning the supply of
money to the economy.
Fiscal policy is described as being neutral, expansionary, or contractionary. An
expansionary fiscal policy occurs when the government lowers taxes and/or
increases spending; thus expanding output (national income). An increase in
government spending or a cut in taxes shifts the aggregate demand curve to the
right. An expansionary fiscal policy will expand the economy's growth. A
contractionary fiscal policy occurs when the government raises taxes and/or
lowers spending; thus lowering output (national income). A decrease in
government purchases or an increase in taxes shifts the aggregate demand
curve to the left. A contractionary fiscal policy will constrict the economy's overall
Fiscal policy in India always had two major objectives, namely, improving the
growth performance of the economy and ensuring social justice to the people.
Fiscal policy influences growth performance of an economy mainly in two ways.
In the first place, it affects growth by influencing the mobilization of resources for
development. Secondly, it exercises its influence by improving the efficiency of
resource allocation.
Apart from tax revenue other important aspects of resource mobilization are
generation of non-tax revenues, restricting of current government expenditure
and raising of surpluses of public sector enterprises.
Fiscal policy also influences growth performance of an economy through its
effects on the allocation of resources. A efficient and rational allocation of
resources will obviously be helpful in raising the rate of economic growth.
Therefore, if fiscal policy favorably affects the efficiency of resource allocation,
then in the process, growth performance of the economy is bound to improve. An
indifferent fiscal policy adversely affecting the efficiency of resource allocation on
the contrary retards the productive activity and thereby results in lower rate of
economic growth.
It is often doubted whether India’s fiscal policy conforms to the principal of equity.
For assessing the equity implications of the fiscal policy it is necessary to analyze
as to who benefits from public expenditure. For India so far no comprehensive
study has been made on this aspect of the fiscal policy.
Major and Subsidiary objectives of economic policy
Static efficiency (short-run)
 Satisfaction of private consumption wants
 Satisfaction of public wants.
 Balance of payments equilibrium.
 Price stability.
 Removal of market imperfections.
National cohesion
 Economic independence
 Provisions of economic symbols of nationhood.
Social justice
 Increased employment
 Reduced inter-personal income inequalities.
 Reduced inter-regional income inequalities.
Economic development (long-run)
 High savings
 Maximum capital inflows from the rest of the world.
 Structural change.
 Reduced population growth.
The short-run objective of private consumption wants implies greater disposable
incomes with people, more imports of goods to improve the consumption
standards of people, and more spending in the economy.
This comes in conflict with,
 The objective of satisfaction of public wants-which requires, more savings by
people which are channeled into public sector to provide for public goods.
 Balance of payments equiblirium which requires-controlling import bills.
 Price stability which requires controlling disposable incomes of people and
ultimately demand.
 Long run economic development that aims at bringing about high savings and
a phased out development with conservation of essential resources.
The objective of social justice implies:
 Increasing employment (which may sometimes result in an unproductive work
 Reducing inequalities
But these come in conflict with, long run economic development objectives that
 Elimination of inefficient workers.
 Creation of a rich class that can save in huge proportions and invest for future
development and growth.
 The objective of national cohesion comes in direct conflict with the objective
of economic development since in modern complex set-up, economic
development cannot come above without a lot of global interaction and these
can threaten national cohesion to some extent if people regulatory measures
are not adopted.
The long term objectives are very important and should be given maximum
priority. If population rate is brought down, and high savings rates achieved then
in the long run the remaining objective of employment generation, improved
consumption levels, self-sufficiency will automatically achieved. If economic
development is raised and self sufficiency attained in long-run then the objective
of national cohesion will also be fulfilled.
So, in my view the maximum preference should be given to long run objectives.

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