Introduction

Fiscal policy is the govt. programme of making discretionary changes in the pattern and level of its expenditure, taxation and borrowings in order to achieve intended economic growth, employment, income equality and stabilization of the economy on a growth path. The term "fiscal" has been derived from the Greek word 'fisc' for basket which symbolizes the treasury or the public purse. It simply means the exchequer or the government treasury. Fiscal policy is that part of economic policy which is mainly concerned with the revenues and expenditures of the government. It often includes public debt. Resources are raised through taxes, non-tax sources and borrowings within the country and from abroad. The policies that the government pursues in respect of raising revenues, levying taxes on income, commodities, services, exports, imports and those relating to public expenditure have a tremendous impact on the economy. Broadly speaking, fiscal policy is concerned with raising and spending financial resources and public debt operations to influence the economic activities of the community in desired ways. It is also concerned with the allocation of resources between the public and private sectors and their use in accordance with national objectives and priorities. It aims at using its three major instruments-taxes, public expenditure and public debt-as balancing factors in the development of the economy. Types of Fiscal Policy Expansionary fiscal Policy An increase in government spending and/or a decrease in taxes designed to increase aggregate demand in the economy. The intent is to increase GDP an decrease unemployment. Contractionary Fiscal Policy: Decrease in government spending or increase in taxes designed to decrease aggregate demand in the economy. The intent is to control inflation

OBJECTIVES OF FISCAL POLICY

To mobilize resources for economic growth, especially for the public sector. To promote economic growth in the private sector by providing incentives to save and invest. To restrain inflationary forces and recession in the economy in order to ensure price stability. To ensure equitable distribution of income and wealth so that fruits of economic growth are fairly distributed

Main tools of Fiscal policy 1) Public Expenditure/Government Spending

One of the tools of fiscal policy is government spending. Government expenditure or spending can be categorized in three ways: 1. Spending on goods and service- Governments can buy planes and military equipments for its defense forces. They can also buy materials for constructing schools, colleges, hospitals, ports, airports, highways, factories etc. Governments can also buy consulting and banking services from consulting and banks to help them on specific projects. Thus, government can directly affect the aggregate demand (AD). 2. Transfer payments- It involves payments to individuals by the government under several welfare schemes such as unemployment benefits, elderly pensions, healthcare benefits or food coupons. Economists believe that changes in government transfer payments influence peoples spending decisions. Higher transfer payments are similar to higher income. However, recipients for such payments may decide to either spend or save the amount. 3. Net interest payments- Most governments have debt which they raise by issuing bonds to banks or other brokers. Governments pay interest rates to people who hold these bonds or debt. Hence, any increase or decrease in the interest rate will directly affect the income from these bonds. If interest rates are increased, government will have to pay more interest payments to people who hold these debts. This would be considered as extra income and may influence spending. By changing its spending, government can influence aggregate demand in the economy. For example- if government decides to spend more (as Indian government has decided to do now) on say infrastructure, there will be increased demand for different goods such as cements and steel and services such as manpower and consulting. This will increase aggregate demand in the economy.

2) Taxation/Government Revenue

Government generates revenue by collecting taxes from its people and businesses. Across the globe, maximum tax is collected as payroll taxes i.e. income taxes, followed by corporate taxes. The next largest category is sales taxes and import duties. By changes tax rates government can influence demand. For example lowering of income tax rate will increase the net disposable income of people. With more money in hand people will spend those money on goods and service; hence, creating a demand for the same.

3) Public Debt Management

The national or public debt is essentially the total accumulation of the deficits (minus the surpluses) the Federal government has incurred through time. Deficits have emerges because of war financing, recessions. The total public debt represents the total amount of money owed by the Federal government to the owners of government securities.

Global Economic Recession

The world capitalist system had been greatly stressed by financial and economic crises, which have threatened the foundation of the system for about two years now. The resultant global economic recession was triggered by financial crisis originating in the US mortgage sector. However, financial crises with global dimension are not new in history. A major one occurred 1928-1933 culminating in the Great Depression. The Great Depression occurred after a dramatic expansion in debt and money supply, first in the 1920s, and later in 1929-1933 due to debt default. Latest financial crisis similarly originated in rapid risky debt accumulation and loss of investors confidence in the US sub-prime mortgage market. It resulted in liquidity crisis. In September 2008, the crisis deepened, as several stock markets crashed and many banks, mortgage lenders and insurance companies failed. Spread of the crisis worldwide was due to the linkages of the world economy arising from economic globalization.

Worldwide effect of Economic recession

Economic recession, output losses, higher unemployment and poverty; reduced capital inflows including aid, and increased capital flight; Exchange rate and balance of payments crisis. Adoption of expensive rescue packages to bail out troubled financial systems.

Impact of recession on India

A slowdown in the US economy was bad news for India. Indian companies had major outsourcing deals from the US. India's exports to the US had also grown substantially over the years. Indian companies with big tickets deals in the US were seeing their profit margins shrinking. More people have sold the shares in the Indian share market than they bought in the recent weeks. This had added to the fall of sensex to lower points. One danger meanwhile was of a dip in the employment market. There was already anecdotal evidence of this in the IT and financial sectors, and reports of quiet downsizing in many other fields as companies cut costs Projects that were halfway to completion, or companies that were stuck with cash flow issues on businesses that were yet to reach break even, ran out of cash. One of the casualties this time was real estate, where building projects were half-done all over the country and in this tight liquidity situation developers found it difficult to raise finances the only way out of the mess was for builders to drop prices, which had reached unrealistic levels and assumed the characteristics of a property bubble, so as to bring buyers back into the market, but there was not enough evidence of that happening. Consumers were also frozen in this sudden glare of the headlights. More expensive money meant that floating rate loans began to bite even more; even those not caught in such a pincer decided that purchases of durables and cars were not desperately urgent. At the heart of the problem were questions of liquidity and confidence. What the RBI needed to do, as events unfolded, was to neutralize the outflow of FII money by unwinding the market stabilization securities that it had used to sterilize the inflows when they happened. This meant drawing down the dollar reserves, but that was the logical thing to do at such a time. If that was done sensibly, it would have prevented a sudden tightening of liquidity, and also not allow the credit market to overshoot by taking interest rates up too high. Meanwhile, there is was upside to be considered as well. The falling rupee (against the dollar, more than against other currencies) meant that exporters who felt squeezed by the earlier rise of the currency could breathe easy again, though buyers overseas now became scarcer. Overheated markets in general (stocks, real estate, employment- among others) had all element of sanity restored. And for importers, the oil price fall (and the general fall in commodity prices) neutralized the impact of the dollar's decline against the rupee.

Different tools used by Government to combat Economic Recession

Monetary Policy Fiscal Policy Taxation Public Expenditure Public Debt Management CRR Bank Rate Open Market Operations

Limitations of Monetary Policy

Targeting inflation is too narrow. This meant Central banks ignored an unsustainable boom in housing market and bank lending. Liquidity Trap. In a recession, cutting interest rates may prove insufficient to boost demand because banks dont want to lend and consumers are too nervous to spend. Even quantitative easing creating money may be ineffective if banks just want to keep the extra money in their balance sheets. Government spending directly creates demand in the economy and can provide a kickstart to get the economy out of recession. Thus in a deep recession, relying on monetary policy alone, may be insufficient to restore equilibrium in the economy.

Role of Fiscal Policy as a Cooping of Strategy in Economic Recession

Role of Taxation - At the time of tax rate is lowered in order to increase purchasing power in the economy. Public Expenditure- increased during recession. By this government try to create employment, boost up business confidence . Public Debt Management Securities are purchased by the government during recession.

How USA used Fiscal Policy as a cooping of Strategy during the Recession In early 2009 the congress passed a fiscal stimulus package The American Reinvestment and Recovery Act $787 billion was to be spent over two years as public expenditure. 1/3 tax cuts was given. 1/3 government purchases was increased. 1/3 transfer payments was increased.

Complete Tax holidays were given to big corporate houses by the President BARACK OBAMA for the corporate to flourish.

Fiscal Stimulus Packages in India

Fiscal Stimulus Packages in India Amount Increase in planned expenditure and tax cuts (INR 200 billion) plus amount provided in the budget for 2008 but mostly unspent (INR 2800 billion) (Total INR 3000 billion, USD 60 billion) Prospective initiative Support to exports, textile sector, infrastructure, housing and SMEs Increase expenditure on public projects to create employment and public assets Petrol and diesel prices cut by Rs 5 and 3 per litre respectively Interest rate cuts on loans for infrastructure and exports Cut of 4% in excise duties across the board on all manufactured goods (except petroleum products) Date Announced 7-Dec-08

Package to help realty and infrastructure sector

India Infrastructure Finance Company Limited permitted to raise funds to provide refinancing to public sector banks in the infrastructure sector External Commercial Borrowings policy liberalized to increase lending to borrowers in the infrastructure sector Countervailing duty and special countervailing duty re-imposed on cement imports

2-Jan-09

Tax cuts

Service tax cut across the board from 12% to 10% Excise duty reduced by 2% for items currently attracting (10%) 10%

25-Feb-09

Criticism of Fiscal Policy

1. Disincentives of Tax Cuts- Increasing Taxes to reduce AD may cause disincentives to work, if this occurs there will be a fall in productivity and AS could fall. However higher taxes do not necessarily reduce incentives to work if the income effect dominates. 2. Side Effects on Public Spending- Reduced government spending to Increase AD could adversely effect public services such as public transport and education causing market failure and social inefficiency. 3. Poor Information -Fiscal policy will suffer if the government has poor information. E.g. If the government believes there is going to be a recession, they will increase AD, however if this forecast was wrong and the economy grew too fast, the government action would cause inflation. 4. Time Lags - If the government plans to increase spending this can take along time to filter into the economy and it may be too late. Spending plans are only set once a year. There is also a delay in implementing any changes to spending patterns. 5. Budget Deficit- Expansionary fiscal policy (cutting taxes and increasing G) will cause an increase in the budget deficit which has many adverse effects. Higher budget deficit will require higher taxes in the future and may cause crowding out (see below 6. Other Components of AD - If the government uses fiscal policy its effectiveness will also depend upon the other components of AD, for example if consumer confidence is very low, reducing taxes may not lead to an increase in consumer spending. 7. Depends on Multiplier- Any change in injections may be increased by the multiplier effect, therefore the size of the multiplier will be significant. 8. Crowding Out- Increased government spending (G) to increased AD may cause Crowding out Crowding out occurs when increased government spending results in decreasing the size of the private sector. * For example if the govt increase spending it will have to increase taxes or sell bonds and borrow money, both method reduce private consumption or investment. If this occurs AD will not increase or increase only very slowly.

* Also Classical economists argue that the govt is more inefficient in spending money than the private sector therefore there will be a decline in economic welfare * Increased government borrowing can also put upward pressure on interest rates. To borrow more money the interest rate on bonds may have to rise, causing slower growth in the rest of the economy.

Conclusion
At the time of Recession Public Expenditure is the most important Fiscal Policy measure as it also takes care of Public debt and Taxation. To keep the Economy Stable there must be a judicious mix of both monetary and fiscal policy