Page 252 - DECO402_Macro Economics

Unit-27: Monetary Policy

(ii) Surplus Budget: Fiscal Policy Under Boom- There is a Notes
surplus in the budget when government expenditure
exceeds the revenue. Policy of surplus budget is
followed for controlling inflationary pressures inside
the economy. It may happen by increase in taxation
pr by decrease in government expenditure or by both.
By it there will be a reduction in income and total
demand, which (reduction) as a result of increased
taxes will be equal to multiplier times of reduction
in government and/or personal consumption
expenditure. It may be made clear with the help of Figure 27.4
figure 27.1. where economy is in initial equilibrium
condition at E .
1
Assume that there is a reduction of amount of ΔG in government expenditure by which total
expenditure function shifts downwards to C + I + G. When E is the new balance situation
which tells that as a result of reduction of E B in government expenditure income falls from
1
OY to OY. Reduction in income Y Y = AE > E B which is the reduction in expenditure because
1
1
1
in consumption also there is a reduction of BA.
When there is an increase in taxes then despite of government expenditure there may be
surplus budget. Increased taxes reduce disposable income of the people and motivate
reduction in consumption. Result is that there is a reduction in total demand, production,
employment and income. It has been made clear in figure 27.3. Before levying tax, C is the
consumption function. Assume that tax equivalent to ET is levied then consumption function
will shift downwards to C . New equilibrium condition is E . Consequently income fall from
1
1
OY to OY . 1
(iii) Balanced Budget Multiplier: Another expansionary fiscal policy is Balanced Budget. In this
policy, amount of increase in taxes and increase in government expenditure is the same. Its
result is that net national income increases. Its reason is that reduction in consumption due
to levying of tax is not equal to government expenditure.

2. Compensatory Fiscal Policy

Objective of compensatory fiscal policy is to compensate economy against unending trends towards
inflation and deflation by adjusting public expenditure and taxes. That is why it becomes necessary for
it that at any definite time instead of measures forever long term lasting fiscal measures are adopted.
When there are deflationary trends in the economy then government must reduce its expenditure
through deficit budget and reduction in taxes. Doing so is necessary for compensating reduction in
personal investment and for increasing effective demand, employment, production and income inside
the economy. At the other side, when inflationary trends are there, the government must reduce its
expenditure by making a surplus budget and increasing taxes so that economy may be made stable
at full employment level. There are two ways of compensatory fiscal policy: (i) Built-in Stabilisers
and (ii) Discretionary Action
1. Built-in Stabilisers: Meaning of built-in stabilisers is that without any plan from government’s
side, adjustment of expenditures and taxes in the process of cyclical ups and downs inside
the economy. Under this arrangement changes happen in the budget automatically that is
why it is also called automatic technique of stabilization. Following are the various automatic
stabilisers—incorporated profit tax, income tax, production tax, survivor and unemployment
insurance and unemployment relief payment. In form of sources of automatic stabilisation
tax and expenditure are related to national income. On unchanged structure of tax rate

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