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What is Fiscal Policy?


 Fiscal policy is the means by which a government adjusts its expenditure and revenue to influence a nation’s economy. While exercising fiscal policy, the government keeps primarily the following factors in mind:

  • Welfare of people
  • Financial condition of government
  • Inflation level in the economy


When the government incurs high expenditure on the welfare of people (i.e. higher salaries and pensions, etc.) and reduces revenue collection (i.e. lower taxes), it has the following effects:

  • People’s standard of living improves.
  • Financial condition of the government deteriorates.
  • Higher expenditure and reduced revenue collection increase money supply and may lead to inflation.


When the government incurs less expenditure on the welfare of people (i.e. lower salaries and pensions, etc.) and increases revenue collection (i.e. higher taxes), it has the following effects:

  • The standard of living of people does not improve.
  • The financial condition of the government improves.
  • Less expenditure and high revenue collection reduce money supply and, therefore, may lead to a fall in prices.


While exercising fiscal policy, the government strives to strike a right balance between the aforesaid three factors. The right balance changes with circumstances as explained below.

When Economic Growth Needs to be Increased

Let us say that an economy has slowed down, unemployment levels have increased, consumer spending has reduced, and businesses are not making substantial profits.

  • In such a scenario, the government increases its expenditure and reduces its revenue, which leads to more funds with people and, consequently, rise in demand, investment, employment, and output. However, any such increase in expenditure and decrease in revenue collection would also depend on the financial condition of the government.
  • Pumping money into the economy by decreasing taxation and increasing government spending is known as “pump priming”. Thus, when the economy is slow, the RBI increases the money supply by exercising monetary policy and the government increases expenditure and reduces tax collection. This is called stimulus package.
  • In other words, a stimulus package is a package of economic measures put together by the government to stimulate a floundering economy. The objective of a stimulus package is to reinvigorate the economy and prevent or reverse a recession by boosting employment and spending.

When the Economy Needs to be Curbed

When inflation is too strong, the economy may need a slowdown. In such a situation, the government can use fiscal policy to increase taxes to suck money out of the economy. Fiscal policy could also dictate a decrease in government spending and thereby decreases the money in circulation.

Of course, the possible negative effects of such a policy in the long run could be a sluggish economy and high unemployment levels.


The effects of any fiscal policy are not the same for everyone. However, broadly the effects of shift in fiscal policy can be stated as follows:

  • When the government decides to increase the taxation, the most affected classes are middle and rich classes. On the other hand, when the government decides to reduce the taxation, the most benefited classes are also middle and rich classes. This is because the rich and middle classes are the tax payers, whereas the poor do not pay or pay very less tax.
  • When the government decides to increase its spending, the benefits are reaped by all classes. However, the poor are the highest beneficiaries because most of the government spending is targeted towards the welfare of the poor sections of our society. Similarly, when the government reduces its spending, the poor are the most affected class.

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Indian Economy