Introduction
Fiscal policy means the use of taxation and government spending which has a direct effect on the overall performance of the economy. Theoretically, it should go inline with the monetary policy of central bank of the country, but fiscal policy is made by lawmakers who are all either directly or indirectly elected by people of each constituency. So they make policies in the interest of people than of nation’s growth.
Objectives
- Keep the inflation rate under control
- Gradual growth to economy
- Promote economic development
- Reduce or eliminate the problem of unemployment
Types
- Expansionary
- Contractionary
Expansionary
- It is used to stimulate the economic growth especially during the time of recession where the businesses struggle to survive. In this model the government either cuts down the tax rate or increase its own spending or sometimes both so that the end effect is more money will be available at consumers to spend which in turn will help increase the demand to keep the businesses running. A positive growth in business will eventually solve the problem of unemployment. There are two sides to this type of fiscal policy.
- People who are in supply side of economics prefer tax rate cut than increase in public expenditure. The reason is that reduction in tax rate will help free the business to expand and make more capital investment which will further stimulate growth. At the consumer side they will have more money to spend which drives business. But the problem here is that in practice people tend to save their excess money rather than spending.
- Demand side economist advocates that additional public expenditure is more effective because it increases public works in critical components of the economy like railways, infrastructure where the role of private sector is limited. Moreover, these are mass employed areas so an increased spending in these will lead to increase in employment.
Contractionary
This is exactly opposite to former one as it is used to slowdown the economy. This is generally used when the inflation is out of control which is very rare cases examples of such instances are in countries like Venezuela. This applies the same tools as that of expansionary but in reverse direction i.e the tax rate will be increased and government spending will decrease which will pull out the surplus liquidity in the economy.
Evaluation of fiscal policy
It depends on several factors of which some are as follows
- The multiplier effect, how well the efforts of government has passed onto each aspect of the economy. Economy is like a spider web changes or disruption made in one place will affect the entire structure but it depends on how well the change has been executed to achieve desired results.
- State of the economy, such as in recession, the economy will respond much better where monetary policy alone may not be sufficient to boost the demand.
- If there is an increase in interest rate and global economy is in recession then fiscal policy plays a important role in providing cushion to the economy from external shocks.
- Bond yields, during expansionary policy excess spending than revenue by government, comes from borrowing from outside. This has a great effect because later this money has to be repaid along with the interest payment which will increase future borrowing and sometimes lead to a debt trap.
- Increase in tax rate during contractionary policy may lead to a reduction in production as people may be demotivated to work and pay more taxes.
- Increase in public expenditure by the government can reduce private investment as they will not be willing to spend when the government is spending. This will affect the entire efforts made by a government.
Conclusion
Fiscal policy is a critical tool to shape the economy in the right direction. Policy makers should give more importance to nation development than concentrating on their individual constituency’s benefit. There is nothing right or wrong in making of fiscal policy it all depends on how well things turn out in future. Proper implementation is the key to achieve a successful fiscal policy.
