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Fiscal policy deals with the government policy concerning changes in the taxation and expenditure
overheads and components, while Monetary policy, deals with the changes in the factors and
instruments that aect the supply of money in the economy and the rate of interest. These are
routinely used by governments world over in various policy mix or combinations to have desired
eects and to steer the broader aspects of the economy. In case of India as with most other
economies, the government of India deals with scal policy (through Annual Budget and other timely
interventions), while there is central bank (Reserve bank of India), that is responsible for execution of
monetary policy.
Fiscal policy is result of several component policies or mix of policy instruments. These include, policy
on taxation, subsidy, welfare expenditure, etc; investment or disinvestment strategies; and debt or
surplus management. Fiscal policy is an important constituent of the overall economic framework of
a country and is therefore intimately linked with its general economic policy strategy.
Types of Fiscal Policy
Neutral Fiscal Policy: This implies a balanced budget where (Government spending = Tax revenue).
It further means that government spending is fully funded by tax revenue and overall the budget
outcome has a neutral eect on the level of economic activity.
Contractionary (restrictive) Fiscal policy: This policy involves raising taxes or cutting government
spending, so that (Government spending < Tax revenue) it cuts up on the aggregate demand (thus,
economic growth) and to reduce the inationary pressures in the economy.
Expansionary Fiscal Policy: It is generally used for giving stimulus to the economy ,i.e., to speed up
the rate of GDP growth or during a recession when growth in national income is not su cient
enough to maintain the present standards of living. A tax cut and/or an increase in government
spending would be implemented to stimulate economic growth and lower unemployment rates. This
is not a sustainable policy, as it leads to budget decits and thus, should be used with caution.
Various combinations of scal policies
Reduction in Government Spending and no Change in Tax Rates (Contractionary scal policy): This
policy is useful in moderate ination, which though is part of governments priority, is not the
foremost objective. This would aect the growth little and sometimes even boost growth due to cut
in ination.
Reduction in Government Spending and Increase in Tax Rates (Contractionary scal policy): This
policy is useful in high ination, when curbing ination is the foremost objective, even above the
economic growth in the short run.
Rigid Government Spending and Increasing Tax Rates (Contractionary scal policy): This is used when

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Rigid Government Spending and Increasing Tax Rates (Contractionary scal policy): This is used when
economy is overheated (When a prolonged period of good economic growth and activity causes high
levels of ination as producers overproduce and create excess production capacity in an attempt to
capitalize on the high levels of wealth) due to too much excitement on the part of investors. Increase
in taxes and interest rates (through monetary policy) would curb the investments in short-run and
prevent economy from going into recession after over-heating.
Reduction in Government Spending and an Equivalent Reduction in Taxes (Balanced Fiscal Policy):
This, is a balanced budget approach, when a government decides to reduce its size and level of its
intervention in economy, then this policy can be adopted. It simply means government is managing
less money and hence less impact on markets and business.
Increase in government spending and tax rates (Balanced scal policy): This would be opposite to the
previous policy as it would increase the size of government. A government on the path of
socialization would adopt such policy.
Increase in government spending and decrease in tax rates (Expansionary scal policy): This would be
adopted to give economy a stimulus though injection of funds, rst the government decreases taxes
and leaves more income with people to spend and invest, then it also spends more to give further
boost to demand through additional income generated through government work. This is only
possible in short-run as this policy leads to massive decits and thus, should be used when situation
is alarming.
Increase in government spending and no change in tax rates (Expansionary scal policy): This is also
a stimulus policy (through public sector), but a more moderate one, which can be used for a bit
longer compared to previous.
Rigid Government spending and decrease in tax rates (Expansionary scal policy): This policy is
usually adopted to give incentive to private sector to invest and boost growth. Again, a short-run
stimulus policy like previous two.
Tools of scal policy
Components of Spending
Maintenance (including sta salaries): This component cant be altered in short-run and hence is
hardly a part of policy making, however, in long-run, through VRS and reducing new jobs in public
sector or vice versa, this expenditure can be altered.
Loan payments: This again is a component, which cant be touched in short-run, however,
governments in long-run can reduce these payments or eliminate them by running the budget
surplus.
Subsidies: This component is a major part of policy as it can be altered in short-run, but
unfortunately, subsidies as policy instrument, have been abused in India. These are used by
politicians as poll promise and political instruments to gain more popular support. Ideally only
meritorious subsidies shall be in operation and all the wasteful subsidies must be phased out, for
example, fertilizer subsidy and power subsidy benets the large farm holder and capitalist farmers
instead of the needy ones. Similarly, the recent example of Aam Aadmi Party manifesto is a good
example, how subsidies should not be used. In place of these, subsides for health programs,
renewable energy, public transport shall be encouraged to ensure good health and sustainable
growth.

Welfare schemes: These are one of the policy options that once introduced cant be removed due to
their populist nature. Similarly, in most of the cases these are necessary too and important

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their populist nature. Similarly, in most of the cases these are necessary too and important
instrument of social welfare and economic growth. However, it is the implementation part, which is
key, as these schemes generally suer from poor implementation and massive corruptions and
loopholes. Thus, despite being meritorious expenditure in nature, these at time appears as waste.
Wasteful expenses: Needless to say these are the expenditures that must be curbed with
immediate eect; however, no government in world has neither shown the intention to curb them,
though there are eorts to reduce them from time to time under public pressure. For example, full
page government advertisements in newspaper to generate favorable public opinion.
Components of Earning
Tax: single: Single most important source on government revenue is also a very important policy
measure as elaborated in the policy combinations above.
Borrowing: Borrowing is a necessary source of funds, though not a desirable one. Particularly, in
developing countries, as tax/GDP ratio is low due to less per capita income. However, it becomes an
important part of monetary policy as well due to its impact on interest rates and credit creation and
thus, overall money supply.
Proceeds from sale/lease of assets: This is a both a one-time and regular source of income. For
example, lending government buildings for private use, or other assets such as telecom spectrum or
lease of a mine block for certain years, is a regular source of income, whereas sale of PSUs is a
onetime income. These however, are good sources of revenue, as they provide government more
room to spend without increasing taxes.
Prots from PSU: Prots from PSUs can also be a potential source of revenue, however, since most
of PSUs are generating losses, Indian government usually ends up subsidizing them. At times PSUs
are deliberately kept in losses to keep prices low and ensure wider outreach for social welfare,
example, PSU banks in pre-reform era and post-o ces. Similarly, at other times, they are in losses
due to ine ciency and wasteful expenditure. Most striking case in India, is of ministerial corruption
to keep PSUs in loss deliberately to benet private sector, for example, CAG report says that, Indian
Airlines was deliberately kept in losses by avoiding ights on protable routes to benet private
airlines during UPA governments rule. Similarly, in previous NDA government, BSNL was deliberately
pushed into loss, by increasing taris to provide competitive edge to a newly launched company by
one of the biggest business conglomerate in India.

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