What is Fiscal Policy
Fiscal policy is the policy adopted by any government to check the expenses and increase revenue inflow methods. Control in expenses help in strengthening the economy of the country. Taxation and government expenditure are the two main pillars of fiscal policy. Interest rates, tax rates and government expenditures are worked out under fiscal policy.
The main motive of fiscal policy is to stimulate economic growth. During recession period, economy is at a low and some impetus is required to keep it stable. This impetus is achieved by reduction in taxes and interest rates and by controlling government expenditure. This process of providing impetus is popularly known as Pump Priming in economic circles.
Fiscal policy follows three modes: first mode is the presence of balanced economy. Fiscal policy in this situation does not involve any measurable action in regards to lowering or increasing interest or tax rate. Fiscal policy in expansionary mode implies increase in government expenditure in comparison to tax revenues. Contractionary fiscal policy implies more tax revenue being generated as against government expenditures.
Government in USA did not take part in economic development issues till the period of Great Depression. F.D. Roosevelt encouraged drafting of fiscal policy for the first time in US. However, in modern times US has failed to formulate a strategy to reduce budget deficit. Just to relieve tax payers, fiscal policy has been amended many a times but this has resulted into slow economic growth with budget deficit standing in the order of trillions.
Incidences like 9/11, oil shocks and undue expenditure in the name of military support to foreign countries have worsened the scene altogether. As a result, sharp increase in food prices can’t be controlled leading into unprecedented inflation. Formulating a sound fiscal policy is strongly needed in present scenario.
Fiscal policy should not be confused with monetary policy. Monetary policy is related to changes in interest rates by a centralized bank whereas fiscal policy is baby of government ideology. Government takes care of taxation as well as expenditure to control fiscal problems. Monetary policy focuses on the flow of money in the system whereas fiscal policy deals with revenue generation methods to overcome government expenditure.
There is no direct relation between fiscal and monetary policies. However, both are accepted to work in a complemented fashion. Both should work to meet the final objective else results may be appalling. If there are any changes made in tax structure under fiscal policy then changes in interest rate should be made so as to avoid double burden on the common public.
Both the policies work in unison in the situation of demand shock and these take contradictory directions in case of supply shocks. Hence, working of both the policies, with full awareness, is critical to stabilize the economic situation.