Fiscal Policy and its Implications in Detail with its Instruments

The use of taxes and spending by the government to affect a nation's economic performance is known as fiscal policy. It is essential for controlling economic volatility, encouraging expansion, and accomplishing macroeconomic goals like price stability and full employment. Fiscal policy has wide-ranging effects on consumer behavior, investment, inflation, and the distribution of income in society.

Fiscal policy and its implications is a vital topic to be studied for the economics related exam such as the UGC NET Economics Examination.

In this article the readers will be able to know about the following:

• Fiscal policy Meaning
• Fiscal policy Implications
• Fiscal policy instruments

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Fiscal Policy Meaning

The strategy and activity of the government toward specific objectives and the macroeconomic environment, encompassing both the earning and spending sides of the economy, is known as fiscal policy. Together with monetary policy, it is a crucial part of the framework for economic policy since it seeks to direct growth, price stability, employment, and aggregate demand.

Fiscal Policy Implications

Fiscal policy is the means through which the government can impact the economy by way of taxation and government spending. The inferences from fiscal policy are discussed below in individual paragraphs:

Economic Stability

By modifying government spending and taxation levels in accordance with the status of the economy, fiscal policy assists the government in stabilizing the economy. Many governments may pursue expansionary fiscal measures during a recession. It accomplishes this by raising government spending and/or reducing taxes in order to boost investment, consumption, and aggregate demand. Conversely, contractionary fiscal measures may be implemented if the economy is discovered to be overheated or if there are signs of inflationary pressures at any given time. These measures decrease inflationary pressures and prevent an overheated economy by either raising taxes or decreasing government spending.

Aggregate Demand Management

One of the key goals of fiscal policy is to control aggregate demand in the economy. In fact, there are direct changes in consumer spending, business investment, and total demand when there are alternations in government spending and taxation. Governments alter fiscal measures to raise overall economic activity, production, and employment. Through expansionary fiscal policies, it leads to economic growth and development and job creation during low activity or recessions. Contractionary fiscal policies also lead to repression of inflationary pressures and provide price stability through a reduction in excess demand in an economy.

Investment and Growth

Fiscal policy also assumes importance in promoting long-term economic growth and development. It can do so by means of infrastructure projects, expenditure on education and health, and research and development. An increase in the level and quality of productivity attained by the economy will most definitely attract certain private sector investments because of the heightened competitiveness enabled by the government. It, therefore, encourages private sector investments by creating an enabling environment for the expansion of business and innovation in the form of tax incentives as well as subsidies. It enhances sustainable growth in the economy, an increase in the employment opportunities, and ultimately improvement in the general standards of the living by people.

Income and Equity Distribution

Fiscal policy can also be used to attain social equity goals and reduce socio-economic disparities. The tax systems in most economies have been used to reduce inequalities and finance other social welfare policies. Public expenditure on education, health, housing allotments, and unemployment benefits increases the scope of equality among different sections of society. The fiscal policy reduces income inequality and aims for an equal society by improving social mobility.

Fiscal Sustainability

Fiscal sustainability is a key factor for the well-functioning of an economy in the long run. Any decision regarding fiscal policy should take into consideration the impact on government finances, the level of public debt, and future generational fiscal burdens. Prudent fiscal management includes maintaining budgetary discipline, balancing fiscal deficits, and keeping public debt at sustainable levels. Broadly sustainable fiscal policies keep confidence for investors, stable economic growth, and minimize the risk of a fiscal crisis.

The main instruments of fiscal policy contribute to a big extent towards achieving fiscal policy's objectives. These objectives can be summed up as the stabilization of the economy, promoting growth, and ensuring economic stability. Fiscal policy makes use of several instruments to achieve its objectives. The main instruments can be summed up as follows:

Government Expenditure

Government expenditure is the process by which funds are used to construct infrastructure, such as roads, hospitals, and schools. This makes it easier for people to get employment and make enough money to support their families. People may purchase more goods when they are employed, which benefits the entire nation.

Taxes

Taxes are sums of money paid to the government by individuals and corporations. This money is used by the government to fund essential services like firefighters, police, and teachers. Ensuring that everyone gets access to the services they require is facilitated by paying taxes.

Transfer Payments

These are financial aid provided by the government to individuals in need, such as the elderly or unemployed. This enables them to purchase clothing, food, and other necessities. They don't work for this money, but it keeps the economy functioning and improves their quality of life. 

Conclusion

Governments use fiscal policy as a potent instrument to affect economic growth, manage inflation, and lower unemployment. It contributes to the general stability and well-being of an economy through taxing, spending, and transfer payments. Since these choices have an impact on everything from employment prospects to the price of goods and services, it is critical to comprehend their ramifications. 

Fiscal Policy and its implications is a vital topic per several competitive exams. It would help if you learned other similar topics with the Testbook App.

Major Takeaways for UGC NET Aspirants The way the government uses taxes and public spending to affect the nation's economic activity is known as fiscal policy. Fiscal policy ramifications: Among other things, fiscal policy affects economic growth, inflation, employment, and income distribution. Tools for fiscal policy: The three main instruments of fiscal policy are government expenditure, taxation, and transfer payments.

Fiscal Policy And Its Implications Previous Year Questions

1. Which of the following is not a technique of deficit financing?

Options. Internal borrowing

1. Counting currency
2. Printing currency
3. External aid and borrowings

Ans. Counting currency