Fiscal policy serves as an important tool to influence the aggregate demand (AD).
where X=exports and M=imports.
Fiscal policy influences all of these four components of AD. Government can influence ‘C’ by imposing taxes on consumers, i.e., personal income taxes. It can influence ‘I’ by imposing taxes on business profits. Similarly, government can easily change its own spending. It influences ‘X-M’ by means of subsidies provided to the domestic producers, import tax, and so on.
The instruments of fiscal policy are government spending and taxation. Depending upon existing situation of the economy, government can employ either expansionary or contractionary fiscal policy. Expansionary fiscal policy increases the aggregate demand whereas contractionary or deflationary fiscal policy reduces the aggregate demand. Changes in the level, timing and composition of government spending and taxation have an important effect on the economy.
Fiscal policy is the policy of government related to its own expenditure and taxes in order to influence the aggregate demand (AD).It is one of the very important demand –side policies. Demand –side policies focus on changing the AD or shifting the AD curve in the aggregate demand and aggregate supply (AD-AS) model in order to achieve the goals of price stability, full employment, and economic growth.
OBJECTIVES
The major objectives of fiscal policy are as follows:
Full employment:
It is very important objective of fiscal policy. Unemployment reduces the level of production, and hence the level of economic growth. It also creates many problems to the unemployed people in their day-to-day life. So, countries try to remove unemployment and attain full employment. Full employment refers to that situation, where there is no involuntary unemployment in the economy. To attain this objective, government tends to:
- Increase its spending
- Lower the personal income taxes
- Lower the business taxes, or
- Employ a combination of increasing government spending and decreasing taxes
However, in practice, it is difficult to achieve full employment. As the factor markets are not perfect, factor units may lose their jobs and may not get the new jobs immediately.
Price stability:
Both sharp rise and sharp fall in general price level are not desirable. It is because sharp rise in prices makes many goods and services unaffordable to the consumers whereas sharp fall in prices discourages the producers to produce goods and services. So, price stability is desirable. However, it should be noted that the principle that general price level should be reasonably stable is generally accepted, the determination of exact trends which are most satisfactory from the stand point of welfare of society is difficult. There are following three alternative points of view regarding the price stability.
Economic growth:
It is also an important objective of fiscal policy. By means of higher rate of economic growth, the problem of unemployment can also be solved. However, it may create some problems in the maintenance of price stability. The developed countries, like USA, UK, Japan, etc. give attention to the relationship of actual growth rate to the potential growth rate permitted by the consumption – saving ratio, technological considerations and other factors. The less developed countries give emphasis to the increase in the potential growth rate as well as the relationship of the actual and potential growth rate.
Resource allocation:
Resource allocation refers to assigning the available resources of the economy to the specific uses chosen among many possible and competing alternatives. It gives answer to what to produce and how to produce-questions of the economy. Fiscal policy should ensure the optimum allocation of the resources. It should divert the resources from unproductive sectors to the productive sectors of the economy. It is the long-run objective of the government. The emphasis of the government upon the full employment, price stability and economic growth should not overshadow the resource allocation goal.
Increase in Savings:
This policy is also used to increase the rate of savings in the country. In the developing countries rich class spends a lot of money on luxuries. The government can impose taxes on them and can provide the basic necessities of life to the poor class on low rate. In this way by providing incentives, savings can be increased.
Equal Distribution of Wealth:
Fiscal policy is very useful for the achievement of equal distribution of wealth. When the wealth is equally distributed among the various classes then their purchasing power increases which ensures the high level of employment and production.
Control Inflation:
Fiscal policy is very useful weapon for controlling the rate of inflation. When the expenditure on non productive projects is reduced or the rate of taxes are increased then the purchasing power of the people reduces.
Reduce the Regional Disparity:
In the less-developing countries, the regional disparity is found. Some areas are more developed while the others are less developed. Government provides the infrastructure facilities in less developed areas. The tax holiday incentive is also provided in these areas which is very useful in increasing the per capita income.
Check Rapid Increase in Consumption:
Fiscal policy is also used to check the rapid increase in the consumption will be high then the rate of saving will be low and consequently rate of investment will be low. So one country cannot improve its economic condition without increasing the investment.
Ref:
Objective of Fiscal Policy from The Strategist at
http://strategistng.blogspot.com/2013/02/objectives-of-fiscal-policy.html