Name -Om Chandak

Section-B
Subject -Economics Project
Topic- Critical Analysis of India’s fiscal
Second draft
Enrolment No- 2022061
Summited to- Prof. Rohit Jadhav
Summited on-20/10/2022

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 Economics Project

Second Draft
Table of Content-

1. Introduction-
1.1. Today’s Market Condition ……………………………………………………03
1.2. Research Problem………………………………………………………………03
1.3. Aims and Objective……………………………………………………….…..03
1.4. Research
Methodology………………………………………………………….03

2. Chapterization-
2.1. Problems………………………………………………………………………04
2.2. Limitation………………………………………………………………………08
2.3. Fiscal policy through legal
perspective…………………………………………10
2.4. Importance of fiscal’s policy in
India……………………………………………11

3. Fiscal policy……………………………………………………………………….…12

4. Literature Review…………………………………………………………………..12

5. Conclusion…………………………………………………………………………12

6. References………………………………………………………………………….13

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Introduction-

India’s economy in today’s condition is on downward slope. In the recent report released by
IMF cuts India’s GDF growth rate to 6.8% from 7.4%. According to IMF global inflation will
rise to 8.8% from 4.7%. Inflation is also on high in India and this is not only the situation in
India but the current problem of recession is spreading all over the world. Markets of the world
are predicting recession will be followed till next year, according to IMF "The worst is yet to
come and, for many people 2023 will feel like a recession." The markets of the world are
going down.

If the prediction of IMF becomes true and if the condition of economy in present situation is
not improved then it will create chaos. Growth of economy will lower down, prices of product
will increase and income of people will decrease. Increase in inflation and decrease in
employment, growth of economy is bad sign for any economy. Price of oil, daily use products,
essentials products will rise and purchasing power of people will fall which will create a lacuna.
To control the present situation and to see that this situation does not get more problematic
government through its fiscal policy should try to control inflation and recession.

Government using expansionary fiscal policy should try to solve this problem. Expansionary
fiscal policy has 2 ways that are Tax cuts or increased government spending. Aim of
expansionary fiscal policy is to aggregate demand. This policy is useful when there is recession
but what type of fiscal policy should be used when government wants to control growth of the
economy. At that time government may use contractionary fiscal policy. In contractionary
fiscal policy government increases taxes and decrease government spending.

The above mentioned are the 2 ways in which we can control economy.

Research Problem-

As we have seen above that Fiscal policy is useful in the time of recession and it can be useful
when it is implemented successfully, therefore we will study problems and limitations in
implementation of Fiscal policy.

Aim and objective-

1)To find problems in implementation of fiscal policy and explain it.

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2) To find limitation in fiscal policy and explain it.

3)Explain the problems and Implementation of fiscal policy in deep.

Research methodology-

In the Draft1 I have explained problem in Fiscal policy. The thing I have discussed were not
deep and therefore in this draft I have tried to explain problems and limitation in of fiscal policy
and I have also discussed other things related to fiscal policy. I am doing research through
referring website, books, journals, etc.

Chapterization-

1) problems in implementation of fiscal policy-

1)Time Lag- The same lags apply to discretionary fiscal policy as they do to monetary policy.
The recognition lag occurs when policymakers fail to recognise the existence of a recessionary
or inflationary gap. Recognition lags are caused primarily by the difficulty of collecting
economic data in a timely and accurate manner. The current recession was not identified until
October 2008, when the National Bureau of Economic Research's Business Cycle Dating
Committee announced that it had begun in December 2007. Then, more time passes before a
fiscal policy, such as a change in government purchases or a tax change, is agreed upon and
implemented—this is known as the implementation lag. Finally, it will take some time for the
policy to fully take effect on aggregate demand—the impact lag.

Fiscal policy changes are likely to have a particularly long implementation lag. In 1960,
presidential candidate John F. Kennedy proposed a tax cut to help end the year's recession. In
1962, he recommended it to Congress. It was not passed until 1964, three years after the end
of the recession. Some economists believe that the long implementation lag for discretionary
fiscal policy renders it ineffective as a stabilisation tool. Fortunately, automatic stabilisers react
to changes in the economy automatically. As a result, they avoid not only implementation but
also recognition lag.

The nature of bureaucracy contributes to the implementation lag. The CBO estimate that only
a portion of the stimulus plan passed in 2009 will be spent in the next two years exemplifies
the implementation lag. Government spending necessitates bureaucratic approval. A portion of
the stimulus package, for example, must go through the Department of Energy. The

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department's one division is responsible for approving loan guarantees for energy-saving
industrial projects. It was established in early 2007 as part of another effort to boost economic
activity. Sage Electrochromic, a Minnesota-based company, has developed a method for
producing windows that can be darkened or lightened on demand to reduce energy
consumption in buildings. Sage worked for two years a year ago for a guarantee on a $66
million loan to build a plant that would employ 250 people. Its application has been denied. In
fact, the loan approval division, which will be crucial for projects in the stimulus plan, has
never approved any application made to it in its two years in existence!

2) Crowding out- Because an expansionary fiscal policy either increases or decreases

government spending, it either increases or decreases the government budget deficit or surplus.
A contractionary policy will either reduce the deficit or increase the surplus. Fiscal policy, in
either case, has an impact on the bond market. Our monetary policy analysis revealed that
changes in the bond market can have an impact on investment and net exports. In this section,
we will discover that the same is true for fiscal policy.

Crowding out reduces the effectiveness of any expansionary fiscal policy, whether it is an
increase in government purchases, an increase in transfer payments, or a tax cut. Each of these
policies raises the deficit, which raises government borrowing. Bond supply expands, interest
rates rise, investment declines, the exchange rate rises, and net exports fall.

It should be noted, however, that private investment is being pushed out. Expansionary fiscal
policy could include increasing the investment component of government purchases. As we
have seen, some government purchases are for goods and services such as office supplies.
However, the government can also buy investment items like roads and schools. In that case,
government investment may be crowding out private investment.

The reverse of crowding out occurs with a contractionary fiscal policy—a cut in government
purchases or transfer payments, or an increase in taxes. Such policies reduce the deficit (or
increase the surplus) and thus reduce government borrowing, shifting the supply curve for
bonds to the left. Interest rates drop, inducing a greater quantity of investment. Lower interest
rates also reduce the demand for and increase the supply of dollars, lowering the exchange rate
and boosting net exports. This phenomenon is known as “crowding in.”

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Crowding out and crowding in clearly weaken the impact of fiscal policy. An expansionary
fiscal policy has less punch; a contractionary policy puts less of a damper on economic activity.
Some economists argue that these forces are so powerful that a change in fiscal policy will
have no effect on aggregate demand. Because empirical studies have been inconclusive, the
extent of crowding out (and its reverse) remains a very controversial area of study.

Also, the fact that government deficits today may reduce the capital stock that would otherwise
be available to future generations does not imply that such deficits are wrong. If, for example,
the deficits are used to finance public sector investment, then the reduction in private capital
provided to the future is offset by the increased provision of public sector capital. Future
generations may have fewer office buildings but more schools.

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"An Expansionary Fiscal Policy and Crowding Out" shows the impact of an expansionary
fiscal policy: an increase in government purchases. The increase in government purchases
increases the deficit or reduces the surplus. In either case, the Treasury will sell more bonds
than it would have otherwise, shifting the supply curve for bonds to the right in Panel (a). That
reduces the price of bonds, raising the interest rate. The increase in the interest rate reduces the
quantity of private investment demanded. The higher interest rate increases the demand for and
reduces the supply of dollars in the foreign exchange market, raising the exchange rate in Panel
(b). A higher exchange rate reduces net exports. Panel (c) shows the effects of all these changes
on the aggregate demand curve. Before the change in government purchases, the economy is
in equilibrium at a real GDP of Y1, determined by the intersection of AD1 and the short-run
aggregate supply curve. The increase in government expenditures would shift the curve
outward to AD2 if there were no adverse impact on investment and net exports. But the
reduction in investment and net exports partially offsets this increase. Taking the reduction in
investment and net exports into account means that the aggregate demand curve shifts only
to AD3. The tendency for an expansionary fiscal policy to reduce other components of
aggregate demand is called crowding out. In the short run, this policy leads to an increase in
real GDP to Y2 and a higher price level, P2.

In Panel (a), increased government purchases are financed through the sale of bonds, lowering
their price to Pb2. In Panel (b), the higher interest rate causes the exchange rate to rise, reducing
net exports. Increased government purchases would shift the aggregate demand curve to AD2 in
Panel (c) if there were no crowding out. Crowding out of investment and net exports, however,
causes the aggregate demand curve to shift only to AD3. Then a higher price level means that
GDP rises only to Y2.

3)Limitation -

Policy Lags- Timing of the fiscal is very important thing. The desired counter-cyclical effects
cannot be realised unless changes in taxes and government spending are precisely timed. There
is usually some time lag between when a specific action is required and when the effects of a
fiscal measure are felt. The length of this interval determines the effectiveness of a particular
fiscal measure. There are three types of lags in this time interval: recognition lag, administrative
lag, and operational lag

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A) Recognition lag- This is the time between when action is required and when it is recognised
that action is required. This lag may exist when an economic change and a report on the change
do not coincide. The duration of such a lag is three months. If the forecasting is good, it can be
reduced.

B) Administrative Lag- This is the time between when the need for an action is recognised and
when the action is actually taken. This is possibly the most difficult lag to manage. Even when
the need for action is recognised, the sanction from the legislature and executive must take
time, which could range from 1 to 15 months. To reduce such lags and to reduce legislative
and executive red tape, it is critical to keep a ready supply of public works. The inside lag of
fiscal policy is determined by the recognition and administrative lags, and its length, according
to Willes, ranges from 4 to 18 months.

C) Operational lag- The operational or outside lag is the time lag between when action is taken
and when it has an effect on income and employment. According to Albert Ando and E.C.
Brown, changes in personal income taxes cause significant changes in disposable money
income and consumption within a month or two; changes in corporate tax structure cause
changes in corporate spending within 3 or 4 months. Willes believed that the outside lag of
fiscal policy lasts only one to three months. J.G. Ranlett, on the other hand, believes that these
estimates should be revised. He emphasised, using 1960s U.S. income tax data, that changes in
income tax rates affected changes in consumption spending with a lag of about 3 to 9 months.
Even this estimate of fiscal policy's outside lag is much lower than that of monetary policy.

4)Forecasting- Another major limitation of fiscal policy is the practical difficulty of

anticipating future episodes of economic insecurity. The amount of revenue to be raised, the
amount of expenditure to be incurred, or the nature and extent of the budget balance to be
framed cannot be appropriately planned unless they are correctly observed. Indeed, the success
of fiscal measures is dependent on accurate forecasting of various economic activities. It
behaves erratically when it is not present. Wrong forecasting can also lead to lag.

2)Limitations of fiscal policy-

1) Correct Size and Nature of Fiscal Policy- The ability of public authorities to
frame the correct size and nature of fiscal policy on the one hand and predict the correct
timing of its application on the other is the most important requirement for fiscal policy

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 success. It is, however, unrealistic to expect the government to correctly determine the
size, nature of composition, and appropriate timing of fiscal policy.

2) Fiscal selectivity- When monetary policy is general in nature and has an impersonal
impact, fiscal policy is selective. The former allows the market mechanism to function
properly. The latter, on the other hand, directly interferes with the market mechanism
and results in resource allocation that can be interpreted as good or bad depending on
one's value judgments. A specific set of fiscal measures may have an overly harsh
impact on certain sectors while leaving others virtually unaffected.

3) Inadequacy of fiscal measure- Expansion of government spending and tax cuts are
always important components of anti-depression fiscal policy. Naturally, the question
of whether a particular variation in government spending or taxes will produce the
desired results arises. The system will fail to move in the desired direction if the
injections or withdrawals from the circular flow are greater or less than what is required.
As a result, the economy's insecurity is exaggerated.

4) Adverse effect on redistribution of income- Although fiscal policy is thought to

redistribute income, the actual effect is unknown. If income is redistributed in favour
of the low-income classes, whose marginal propensity to consume is high, total demand
will rise. However, fiscal action will be contractionary if a larger portion of the
additional income is distributed to people with a higher marginal propensity to save

.
5) Self – offsetting effect- Government compensatory fiscal policies may discourage
private investment because private entrepreneurs must compete with public enterprises
for labour, raw materials, and finances. Furthermore, increased government
involvement in economic activity at the onset of a recession reinforces private
entrepreneurs' pessimistic expectations. The increase in public spending may be
accompanied by a decrease in private spending. As a result, the fiscal measures may be
self-balancing.

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 6) Reduction in national income- The fact that the marginal propensity to spend of
recipients of public expenditure is greater than or equal to that of taxpayers conditions
the use of the balanced budget multiplier as a fiscal weapon during a depression. If it
becomes smaller than the taxpayers, the fiscal programmes under the balanced budget
will result in a decrease in national income.

7) Solution for unemployment- If fiscal policy cannot maintain a rising supply level
of work effort, its purpose will be defeated. Money national income will rise as
productive efficiency and work effort supply increase. However, if the tax measures are
too stringent and too high, they will undoubtedly reduce the incentive to work. This is
a significant fiscal policy limitation.

8) Adverse impact on debt management - The use of fiscal instruments during

unemployment and depression is frequently associated with the subsequent debt
management problem. Because deficit budgeting is the standard fiscal cure, public debt
is created to fund it. And, if the recovery process from depression is lengthy, creating a
budget deficit year after year will create a massive debt repayment and debt
management problem.

9) Adverse psychological reactions- Large deficit programmes financed by

borrowings elicit negative psychological responses. Rumours of government
bankruptcy discourage investors, and capital often flees.

3) Fiscal policy through legal perspective–

In India “Fiscal Responsibility Budget Management Act 2003” is related to Fiscal policy frame
work in India. Budget, finance commission, etc are the things related to fiscal policy.

Monetary policy is created by the Ministry of Finance. The Fiscal Responsibility and Budget
Management (FRBM) Act of 2003 was passed with the intention of creating a legal framework
for the Central Government's debt and deficit reduction to a manageable level in order to ensure
long-term macroeconomic stability and intergenerational equity in fiscal management.

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Beginning on July 5, 2004, the FRBM Act, 2003 and the FRBM Rules, 2004 created under the
Act went into effect. By the end of March 2021, the Central Government must limit its fiscal
deficit to no more than 3% of GDP, according to the FRBM framework. Additionally, it states
that by the end of 2025, the Central Government shall make every effort to keep the General
Government Debt at 60% of GDP and the Central Government Debt at 40% of GDP. Due to
the unprecedented nature of the CoVID-19 shock, the fiscal deficit increased from 3.5% of
GDP in BE 2020–21 to 9.5% of GDP in RE 2020–21, affecting both economic growth and
other fiscal parameters. The pandemic's effects on uncertainty persisted into 2021 and 2022.
The fiscal deficit target for RE 2021–22 is set at 6.9% of GDP as opposed to 6.8% of GDP in
BE 2021–22 due to higher development and welfare-related spending to combat the pandemic
and aid the populace. The fiscal deficit is anticipated to be 6.4% of GDP in BE 2022–23, which
is less than RE 2021–22.

4)Importance of fiscal Policy in India-

In India fiscal policy a pivotal role, it helps to increase the rate of capital formation in both
public and private sector, it also helps in mobilization of resources, it also helps to reduce
inequality between rich and poor, it also helps in providing stimulus and to increase the saving
rate, etc. Fiscal policy helps in various ways. In a country as big as India fiscal policy plays an
important role.

Fiscal policy in India is the guiding light which helps the government to decide what amount
of money it should spend to support the various economic activities, and how much revenue it
must earn from the system, to keep the wheels of the economy running smoothly. In today’s
world fiscal policy has gain lot of importance in India and even in world. Aim of fiscal policy
in India is to boost the growth of the economy. Fiscal policy in India aims to raise a
considerable quantity of money to fund the government’s various programmes through taxes.
It aims to eliminate inequality in income and wealth distribution by giving sufficient incentives
to the private sector. The objective is to boost both industry and government capital formation.

5) Fiscal Deficit-

A fiscal deficit is a difference between a government's income and its expenditures. It is the
difference between the government's total income and its total expenditures. Borrowings from

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the government make up the difference.A fiscal deficit occurs when a government spends more
than its resources. The difference between the government's income and expenditure can be
calculated as an absolute amount of total dollars spent over income or as a percentage of the
country's GDP (GDP). The state's total income under fiscal deficit includes only taxes and other
revenues. It disregards the government's borrowing. In simple words, Fiscal Deficit is the
excess of total expenditure over total receipts of the country, which often means that fiscal
deficit is equal to borrowings of the state.

• Like every household, the government also maintains a budget, but often to keep up
with the advancements and growth, it spends more than its income by borrowing
through different channels. The centre generally spends on assistance to the weaker
sections of the society or any developmental project, and this spending can cause a
fiscal deficit.
• Although people consider Fiscal Deficit as an adverse event, if a country manages to
sustain deficit spending, it can help in the development of the country. While many see
Fiscal Deficit and Fiscal Debt as the same, the two terms are different concepts. The
Fiscal Debt is the total debt piled up over many years of deficit spending.

Fiscal Deficit = Total expenditure (Revenue expenditure + Capital expenditure) - Total receipts
other than borrowings (Revenue receipts + Capital receipts except for borrowings)

6)Literature Review-
1)fiscal policy in India: review-
https://www.ijeronline.com/documents/volumes/2015/Vol%206%20Iss%2001%20JF%20201
5/ijer%20vol6i1%20JF%202015(6).pdf

The paper deals with the fiscal policy and its tools. Data has been provided regarding revenue
and expenditure of the government. Fiscal deficit has been compared and found that value of
standard deviation is higher in case of Centre government as compared to state government
indicating more variation in deficit. If we talk about the possible causes of fiscal deficit these
are interest payments on borrowings, subsidies, defence expenditure, pressure of population
and high demand for gold etc. High fiscal deficit can heighten inflation, remove effectiveness
of monetary policy stimulants, increase the risk of external sector imbalances and can dampen
private investment. It can also lead do debt trap for the economies. In short, the two phases of
fiscal policy stance immediately before the 2008 global crisis and thereafter are discernible in

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a longer period analysis. The gap between non-debt receipts and total expenditure (as
proportion of GDP) reflects the extent of FD and depicts the shift of fiscal policy from
consolidation to expansion during the two phases.

Conclusion-
Fiscal Policy in India holds an important position in the times of recession but main problem
is not policy framing the problem is implementation of that policy. As we have seen above that
there is various problem in implementation of policy but at the same time fiscal policy also
plays an important role therefore the need of the hour is to work on implementation of the
policy, there is requirement to work on implementation of policy because if fiscal policy is
implemented properly then it can help in growth of one’s economy and bringing stability in an
economy.

Reference-

1. Issues in fiscal policy. (n.d.). Retrieved October 20, 2022, from

https://saylordotorg.github.io/text_principles-of-macroeconomics-v2.0/s15-03-issues-
in-fiscal-policy.html
2. ClearTax. (2022, October 18). Fiscal deficit. Definition, Latest News, and Why fiscal
deficit is Important? Retrieved October 20, 2022, from
https://cleartax.in/g/terms/fiscal-
deficit#:~:text=A%20fiscal%20deficit%20is%20a,is%20filled%20by%20government
%20borrowings.
3. Masibo, B. (2021, September 6). Implementation of fiscal policy: CFA level 1.
AnalystPrep. Retrieved October 20, 2022, from https://analystprep.com/cfa-level-1-
exam/economics/implementation-fiscal-policy/
4. Top 13 limitations of fiscal policy. Economics Discussion. (2015, August 11).
Retrieved October 20, 2022, from https://www.economicsdiscussion.net/fiscal-
policy/top-13-limitations-of-fiscal-policy/4702
5. Issues in fiscal policy. (n.d.). Retrieved October 20, 2022, from
https://saylordotorg.github.io/text_principles-of-macroeconomics-v2.0/s15-03-issues-
in-fiscal-policy.html
6. What is the crowding-out effect? Robinhood. (n.d.). Retrieved October 20, 2022, from
https://learn.robinhood.com/articles/5vuyd3HOvZDNYZwkNrMdJ7/what-is-the-
crowding-out-effect/
7. International Journal of Economics and Research. IJER. (n.d.). Retrieved October 20,
2022, from https://ijeronline.com/

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