Monetary and Fiscal Policy | UGC NET Economics – Notes

Introduction

• Fiscal and monetary policies laid down by governments have an impact on economic environment. They have effect on the supply of money in the economy, credit, changing rates of interest and other related aspects. The government policies are generally coordinated with monetary and fiscal policies for ensuring the welfare of economies.

• The Central bank of the country has the responsibility to manage the liquidity comprising cash, credit, rates of interest to promote economic growth in the country. In India, the Reserve Bank of India (RBI) is the Central Bank which controls inflation in the country through monetary and fiscal policies. The IMF and World Bank have the objective of providing guidance, technical expertise in operationalising of monetary and fiscal policies.

Fiscal Policy: Meaning and Objectives

• The word fiscal is derived from a Greek word Fisc which means the basket that symbolised treasury of government. A fiscal policy is the part of economic policy that is concerned with the State’s income and expenditure to achieve and sustain rapid economic growth in an economy. It includes public borrowing and deficit financing.

• Fiscal policy determines the tax revenue, public expenditure, loans, transfers, debt management, public borrowings, budgetary deficit, etc. Fiscal policy can be defined as the policy that is concerned with the various aspects of the government expenditure and the tax structure. Fiscal policy helps in the fulfilment of the objectives of the monetary policy also. It uses taxes, public expenditure, and public debt as balancing factors in economic development.

• Fiscal policy includes tax policy, expenditure policy, investment or disinvestment strategies and debt or surplus management. While fiscal policy encompasses the taxation and expenditure decisions of the government, monetary policy deals with the supply of money in the economy and rate of interest. It works along with the monetary policy to influence the country’s money supply.

Objectives of Fiscal Policy:

• Economic Development: The fiscal policy ensures economic development through mobilising resources through taxation, savings etc.

• Efficient Allocation of Resources: This is facilitated through directing allocation of funds to specified areas that foster social and economic development.

• Reduction of Inequalities of Income: This is attempted by fiscal policy through appropriate taxation policies.

• Price Stability and Control of Inflation: Fiscal policy lays down methods to control inflation and stabilise prices.

• Employment Generation: The expansion of infrastructure and other schemes and programmes are given a boost by the fiscal policy that promote job opportunities and employment generation.

• Balanced Regional Development: The fiscal policy through tax exemptions, cash subsidies lead to balanced regional development.

• Infrastructure Development: The development of infrastructure in the form of highways, ports, railways, airports etc., is possible through generation of more resources through taxation, public bonds and so on.

• Capital Formation: Fiscal policy facilitates increase in capital that leads to development of other sectors of the economy.

• Foreign Exchange Earnings: The increase in foreign exchange earnings is made possible by the abolition of taxes on export earnings, sales tax etc.

• India’s fiscal system since the early 1900s, especially in taxation has undergone changes. The initial years of India’s planned development strategy had a conservative fiscal policy to keep the deficits under control. The tax system’s objective was the resource transfer from the private sector to the public sector to increase the speed of industrialisation and social welfare. However, the growth did not pick up till the 1991 economic reforms. In India, the fiscal deficit was controlled by 2007–08 and it survived the economic recession with the help of tax cuts and increase in public spending.

Instruments of Fiscal Policy:

• The tools of fiscal policy are:

  • Taxation: This is an important source of revenue in all countries. There are direct taxes paid by an individual such as income tax, corporate tax, taxes on property and wealth. While indirect taxes are levied on consumption. It includes sales tax, excise duty, and customs duty.

  • Expenditure: Expenditure to be incurred on various areas is another instrument of fiscal policy.

  • Public Debt: Borrowings from internal and external sources is another tool of fiscal policy.

  • Deficit Financing: The filling of gap between the revenue and spending of government is deficit financing. This is done either through internal sources of finance such as issuing of bonds and securities or external borrowings from international institutions such as World Bank, IMF etc.

• Fiscal Policy in India: The Constitution of India provides the framework for fiscal policy of India. The federal structure of India has divided the powers of taxation and spending between the centre and states as per the Constitutional provisions and related laws. The states have lesser resources as compared to their expenditure than the Centre. The centre transfers funds to the States through the Finance Commission and other means. The Indian Constitution also provides for the Union Government to present its annual financial statement, the taxation, and the expenditure that it will be incurring in the next fiscal year, in the form of budget which is also prepared by the states.

• In 2003, the Parliament passed, at the Central level, the Fiscal Responsibility and Budget Management Act (FRBM) to institute a new fiscal discipline framework. It aims to introduce transparency in India’s fiscal management system. Its long-term objective is to achieve fiscal stability and to give RBI the flexibility to deal with inflation. It was enacted to introduce more equitable distribution of India’s debt over years. The act has been amended several times.

• On 1st July 2017, the Goods and Services Tax (GST) was introduced and passed as an Act. It is a Value Added Tax (VAT) which is a comprehensive indirect tax levy and the collection of tax on inter-state supply of goods and services is by the central government.