Page 251 - DECO402_Macro Economics

Macroeconomic Theory

Notes investment. In this way through a strategically combination of expenditure and taxation programmes
government may control inflationary and deflationary pressures in the economy. Now we will discuss
various sources of Fiscal policy-
1. Budgetary Policy: Contra Cyclical Fiscal Policy
Budget is an important source of fiscal policy. Budgetary policy controls the results and relations of
receipts and expenditures of fiscal policies. Further we discuss those general budget policies, which
are adopted for stabilising the economy:
(i) Budget Deficit: Fiscal Policy under Depression- Deficit budget is an important measure to
control depression. When government expenditure exceeds its receipts then in the thread
of national income more than that quantity is put in as much has been taken out from it.
Deficit expresses net expenditure of the government which increase the national income
multiplier times the net expenditure. If MPC is 2/3, multiplier will be 3 and if in government
expenditure there is a net increase of ` 100 crores then
it will increase the national income to ` 300 crores. In
this way budget deficit puts an expansionary effect
on total demand, even if by fiscal process marginal
tendencies are unchanged and disposable receipts are
redistributed. Expansionary effect of the budget has
been shown in figure 27.1 in non-linear form. C is the
consumption function. C + I + G expresses consumption,
investment and government expenditure (total
expenditure function) before the presentation of budget.
Assume that government expenditure G is increased in
the economy. Consequently, total expenditure function
shifts upwards to reach C + I + G’. Income increases Figure 27.2
from OY to become OY where as equilibrium situation moves from E to E . In comparison
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to increase in government expenditure E B (= Δ G) increase in income YY + EA = E A is
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more. BA (E A – E B) expresses increase in consumption. In this way budget deficit is always
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expansionary because as compared to amount of actual government expenditure there is
more increase in national income. In this method of budget deficit taxes are kept as it is.
Budget deficit may be obtained by doing reduction in taxes and without reducing government
expenditure. Reduction in taxes leaves comparatively more disposable income in hands of
the people and in this way increased consumptions induce expenditure. As a result it further
increases total demand, consumption income and employment. It has been clarified in figure
27.2 where C is the original consumption function. Assume that quantity ET is reduced in
taxes. By this consumption function will shift upwards
and reach C’ and from OY income will increase to
become OY .
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But reduction in taxes is not very expansionary from the
path of increased consumption expenditure, because it
may happen that tax relief is not spent on consumption
and is saved. If business expectation are low then it may
happen that traders may also not invest much. For saving
from such dangers what government need to do is that
he along with reduction in taxes also follows the policy
of government expenditure. Its multiplier effect will
be much more in that situation when we assume that
because of tax relief some consumption and investments Figure 27.3
also increase.

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