What is Fiscal Policy?

The word fiscal is derived from the old French Word Fisc, which means the money basket or the treasury. Thus fiscal means pertaining to treasury or government finance. Fiscal policy means the government policy of taxation, expenditure and public debt etc. Fiscal policy may be defined as ‘a policy under which the government uses its expenditure and revenue programmes to produce desirable effect & avoid undesirable effect on national income, production and unemployment. It emphasizes the effect of government expenditure and revenue upon total economy and argues that they should be used deliberately and consciously as a balancing factor to secure economic stabilization. “Gerhard Colm defines fiscal policy as “the conduct of government expenditure, revenues and debt management in such a way as to take fully into account the effect of these operations in the allocation of resources and the flow of funds and thereby their influence on the level of income prices employment and production.”

In the modern government organization the amounts of public expenditures, revenues and public debt are so huge, that they have began to assume a major importance in the national economy. The desired fiscal policy can be pursued by budgetary measures like taxation, expenditure, public debt etc.

The role of fiscal policy in regulating the economy and protecting it from the ills of the market mechanism were recognized very slowly. As discussed in an earlier lesson, governments were wedded to the traditional ideals of sound budgetary policy of avoiding deficits. Such a policy, amongst other things, was causing to problems. One was as Keynes pointed, the fact that an attempt to balance the budget would put it to an unbalance and vice-versa. The second was that through the process of balanced budget multiplier, the budget was adding to the severity of cyclical fluctuations. It was with great difficulty that the appropriateness and usefulness of the fiscal policy in combating the ills of the economy were recognized, especially during the great Depression of 1930s. It was conceded that the government had a primary responsibility of helping the economy towards stabilization.

As mentioned earlier, the role of fiscal policy in promoting economic stability was recognized slowly, and not sufficiently till the Great Depression of 1930s, Actually, as Keynes pointed out, the orthodox sound budgetary policy of avoiding deficits itself contributed towards greater instability and made the task of keeping the budget balanced, all the more difficult. This is fact, generated a “perverse” policy on the part of the authorities, pushing the expenditure and demand in the economy down during a period of depression and pushing them up during a boom.

The development of the concepts of “multiplier”, and accelerator” and the relationship between the macro-variables like investment, Income consumption and savings enabled the economics to visualize more clearly the machines of trade cycles and the role which fiscal policy could play. This gave rise to the principle of compensatory finance and functional finance. It was realized that through fiscal policy, the government could to a great extent, neutralize the destabilizing movements in the economy. The general theoretical farm work was that a depression is caused by a deficiency of effective demand. Fiscal policy should remedy it by increasing public expenditure and by encouraging private expenditure; similarly during a boom period the need is to control the demand which again can be partly done through curtailing public expenditure and party through curbing the private expenditure.

To encourage demand during depression, the authorities should reduce the tax rates or abolish taxes on various items & activities. This would push up profits and reduce the price through a reduction in the cost of supply. Lower prices are expected to increase demand, production and employment, which in turn would bring further increase in demand and so on. A similar action can be taken in the field of custom duties also. Raising import duties would divert domestic demand from imports to home produced goods or abolishing export duties or giving export subsidies would increase the demand for exports and would contribute towards recovery from depression.