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What is Fiscal Policy and how it used to correct Excess Demand and Deficient Demand?

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Meaning of Fiscal Policy

A fiscal policy is the policy of the central government which aims at controlling the situation of the money supply in the economy. Simply put, fiscal policy includes using taxation, government spending, and borrowing to change the level and growth of output, aggregate demand, and jobs. It is also used by the central government to change the spending pattern on goods and services. Another name for fiscal policy is the Revenue and Expenditure Policy. The main constituents of Fiscal Policy are Expenditure Policy, Revenue Policy, Public Borrowings, and Deficit Financing. With the help of fiscal policy, the government of a country can influence the level of economic activities. Also, a change in the fiscal policy affects the Aggregate Demand (AD) and Aggregate Supply (AS) of an economy; therefore, it can be used to correct Excess Demand and Deficient Demand.

Fiscal Policy to correct Excess Demand

Fiscal Policy to correct Excess Demand

 

When there is Excess Demand in an economy, a fiscal policy is formed with the aim of reducing the level of Aggregate Demand with the help of the following measures:

1. Expenditure Policy (Decrease in Government Spending):

Government invests a significant amount of money in developing things like highways, flyovers, buildings, railway lines, etc. A change in such spending has a direct impact on the amount of aggregate demand in the economy and helps in the management of excess and deficient demand conditions. Government spending should be as low as possible in order to manage the condition of excessive demand. Greater attention should be placed on reducing defence and unproductive expenditures, as these rarely contribute to a country’s growth. Reduced government spending serves to lessen inflationary pressures in the economy by lowering the level of aggregate demand.

2. Revenue Policy (Increase in Taxes):

The government charges many types of direct and indirect taxes on the general public. Government Tax changes have a direct impact on the level of total demand and help in balancing excess and deficient demand in the economy. Government raises tax rates and even imposes some additional taxes during periods of excess demand. It results in a decline in total economic spending and helps in managing the condition of excessive demand.

3. Increase in Public Borrowings:

The government borrows money in the form of public deposits from the public. It borrows money (public deposits) in order to withdraw the excess money held by the public during periods of excess demand. It helps in a reduction in the money supply of the economy, which as a result reduces the aggregate demand.

4. Decrease in Deficit Financing:

Deficit Financing means printing currency. It increases the money supply in the economy. Therefore, during periods of excess demand, the government avoids deficit financing to prevent an increase in the money supply and hence, aggregate demand.

Fiscal Policy to correct Deficient Demand

Fiscal Policy to correct Deficient Demand

 

When there is Deficient Demand in an economy, a fiscal policy is formed with the aim of increasing the level of Aggregate Demand with the help of the following measures:

1. Expenditure Policy (Increase in Government Spending):

Government invests a significant amount of money in developing things like highways, flyovers, buildings, railway lines, etc. A change in such spending has a direct impact on the amount of aggregate demand in the economy and helps in the management of excess and deficient demand conditions. Government spending on public works should be increased as much as possible in order to manage the condition of deficient demand. This will enhance aggregate demand and help to correct the issue of deficient demand.

2. Revenue Policy (Decrease in Taxes):

The government charges many types of direct and indirect taxes on the general public. Government tax changes have a direct impact on the level of total demand and help in balancing excess and deficient demand in the economy. In case of deficient demand, Government decreases tax rates and even eliminates some taxes. It increases the purchasing power of people, making them capable of spending more on consumption and investment because of an increase in their disposable income. It increases overall demand and helps in managing the condition of deficient demand.

3. Decrease in Public Borrowings:

The government borrows money in the form of public deposits from the public. During the period of deficient demand, the government reduces public borrowings to increase the purchasing power of the people. It helps in increasing the money supply of the economy, which as a result increases the aggregate demand.

4. Increase in Deficit Financing:

Deficit Financing means printing currency. It increases the money supply in the economy. Therefore, during periods of deficient demand, the government increases deficit financing to increase the expenditure level or money supply in the economy, which ultimately increases the aggregate demand.


Last Updated : 01 May, 2023
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