Read this article to learn about the meaning, classical and Keynes’ views, objectives and instruments of macroeconomic policy.
We have known that monetary measures alone cannot be successful in staging a recovery and help in creating full employment conditions.
Even in booms their efficacy is limited and the cheap money policy may fail to stimulate business. Under these circumstances, other measures of bringing economic stability and full employment have to be restored to. Amongst other measures fiscal measures occupy special importance.
These measures consist in the purposeful manipulation of public expenditures and taxes and are commonly described as ‘fiscal policy’: Harvey and John son define fiscal policy as ‘changes in government expenditure and taxation designed to influence the pattern and level of activity.”
According to G.K. Shaw, “We define fiscal policy to include any design to change the price level, composition or timing of government expenditure or to vary the burden, structure or frequency of the tax payment.”
In an era of welfare states, public finance, it is argued, should no more remain neutral, but should be adjusted to the changing conditions in the economy, to fight inflationary pressures and deflationary tendencies—popularly called functional finance.
In other words, the policy regarding public expenditures, taxation and borrowing has to be geared to fight inflation and deflation— budgeting has to be contra cyclical. Thus, insofar as the government is in a position to modify its own expenditures or to bring about a change in private expenditures, it can increase or decrease the aggregate demand for goods and services on which the level of income, output and employment depends.
Classical and Keynes’ Views on Fiscal Policy:
The classical concept of fiscal policy intended to limit the size of the public sector by reducing the functions of the government to the minimum possible so that the market mechanism may operate unhindered. The classical concept of fiscal policy regarded the functions of the government pertaining to tax and expenditure as a necessary evil. To them, taxes were nothing more than unproductive expenditures resulting in wrong diversion of resources.
The classical concept of sound fiscal policy conformed to the maxim of Neutral fiscal policy and wanted the public expenditures to be the minimum possible, a tax structure which would disturb the price system as little as possible. They believed in balanced budget because only such budgets could ensure a neutral fiscal policy. Dr. Gunnar Myrdal exposed the fallacy of the classical neutral fiscal policy, which, he argued, did not suit the underdeveloped economies, specially when they want to break the ‘vicious circle of poverty’.
Keynes also exposed the shortcomings of the classical neutral fiscal policy and wanted it to be used as a balancing factor to ‘bring about an adjustment between the propensity to consume and the inducement to invest’.
He regarded fiscal policy as an important means to overcome the deficiency in effective demand. Keynes never gave a formal definition of fiscal policy. However, he understood by fiscal policy a policy that uses public finance as a balancing factor in the development of the economy.
He also considered fiscal policy as an instrument of economic development and advocated changes in it in order to strengthen effective demand to bring about a rise in income, output and employment. Later economists continued to uphold fiscal policy as an instrument of stabilization and growth.
One variant of Keynesian theory of fiscal policy is the theory of functional finance, the basic issue of which is the prevention of both inflation and deflation. A.P. Lerner is the chief exponent of the theory of functional finance.
Fiscal policy has developed under the influence of Lord Keynes. The post-Keynesian popularity of fiscal policy has been largely due to the ineffectiveness of monetary policy as an instrument of removing unemployment, especially during the 1930s, the development of ‘New Economics’ by Keynes with its emphasis on effective demand and the growing importance of taxation and government expenditure in relation to national income and output. From its modest beginning in the 1940s, through the 1950s, 1960s, it has become a major plank and instrument of generating full employment in the 1970s.
In the late 1970s it has been used to contain inflation and promote economic growth. Keynesian economics and fiscal policy measures found respectable place in the macroeconomic policy measures announced by the newly elected president of USA, Mr. Jimmy Carter, in January, 1977.
The emphasis of monetary policy has been on attacking inflation, whereas the emphasis of fiscal policy has been on attacking deflation. Government activities as regards revenue, expenditure and public debt are known as fiscal activities and the deliberate attempts to change and adjust these activities to attain desired objectives—say economic stabilization and full employment—are known as fiscal policy.
Under such a policy we make use of various fiscal measures that are at our disposal to adjust consumption and investment to fight abnormal conditions in the economy. An economy, therefore, that aims at a high and stable level of employment must adopt a suitable fiscal policy designed to maintain effective demand.
Following Keynes, economists have argued that substantial amount of government expenditure and tax income act as important levers in changing the size of national income, employment, level of prices and the tempo of aggregate economic activity in the system. A given change (increase or decrease) in the aggregate government expenditure or tax causes a change (increase or decrease) in the aggregate effective demand, thereby increasing or decreasing factor incomes.
Objectives of Fiscal Policy:
Fiscal policy aims at a number of objectives depending upon the circumstances in a country.
Important objectives of fiscal policy may be:
(a) Optimum allocation of economic resources. It means that the fiscal policy should be so framed as to increase the efficiency of productive resources like men, money, materials, etc. It also means that the government should spend on those public works which give the maximum employment and ate beneficial to society.
(b) Fiscal policy may aim at equitable distribution of wealth and income. It means that differences in payments to the factors of production should be reduced to the minimum and fiscal policy should be so designed as to bring about an equality of incomes between different groups by transferring wealth from the rich to the poor.
(c) Another important objective of fiscal policy may be to maintain price stability. A fall in prices leads to a sharp decline in business activity. On the other hand, inflation may hit hard the fixed income classes and may benefit the speculators and traders. Fiscal policy has to be such as will maintain a reasonably stable general price level benefiting all sections of the society.
(d) The most important objective of fiscal policy is the promotion and maintenance of full employment; because through it all other objectives are automatically achieved. For this, fiscal authorities should start programmes of removing unemployment. For the moment, it suffices to say that fiscal policy aimed at full employment envisages the erection of a tax structure, not with a view to raising revenue but with a view to noticing the effects that specific kinds of taxes will have on consumption, saving and investment; and the determination of the volume and direction of government spending not to provide certain services only but also to know how it will fit into the general pattern of total spending currently taking place in the economy.
These objectives are not always compatible, particularly price stability and full employment. The objective of equitable distribution of income may come in conflict with the objective of economic efficiency and economic growth.
Fiscal policy may transfer wealth from the rich to the poor through the use of taxation with a view to bringing about a redistribution of income, but it may be criticized on the ground that the transfer of income from the rich to the poor will affect savings and capital formation, which in turn, would affect investment and employment.
Fiscal policy as a means for influencing the flow of income may involve either a change in the level of taxes or a change in the level of government expenditures or a combination of the two. Whatever method is adopted the basic consequences are the same.
To impose restraint increased taxes or reduced expenditures may result in a surplus of tax revenues over expenditures. To encourage expansion, reduced taxes or increased spending may cause a deficit of revenue as compared to expenditures.
Instruments of Fiscal Policy:
Fiscal policy is based on the thesis that it can influence the total level of aggregate spending through changes in the level of individual and corporate incomes. The tools of fiscal policy are taxes, expenditure, public debt a nation’s budget.
They consist of government revenues or rates or the tax structure in such a way as to encourage or restrict private expenditures on consumptions or investment. They also include government expenditures comprising normal government expenditures, capital expenditures on public works, relief expenditures, subsidies of various types, transfer payments and social security benefits.
It will be seen that government expenditures are income creating while taxes are primarily income reducing. Management of public debt or national debt in most countries has become an important tool of fiscal policy.
It aims at influencing aggregate spending through changes in the liquid asset position. Thus, it may be said that the instruments of fiscal policy not only include the multitude of different kinds of taxes that are or that can be levied as well as the detailed features of these taxes, but also include government spending including grant of subsidies, price support programmes, civil and military expenditures and expenditures on public works as well as relief programmes.