What fiscal policy entails

Fiscal policy refers to the manipulation of government revenue and expenditure to achieve policy objectives associated with:

  • Moderating resources allocation and adjusting price mechanisms in favour of the satisfaction of public wants by encouraging socially optimal investments as well as increasing rate of investment;
  • Redistributing wealth and income;
  • Guiding the national economy in terms of growth and stability;
  • Increasing employment opportunities;
  • Counteracting inflation; and
  • Improving the balance of payments.

The usefulness of fiscal policy is often limited by:

  • Structural constraints in the economies; and
  • Observed conflicts of objectives between long term growth and short term stability; social welfare and economic growth; income distribution and growth and personal freedom and social control.

Basically, fiscal policy can be applied in many ways to influence the economy. For example the government can increase its own expenditure which it can finance by raising taxes, by borrowing from non bank members of the public and/or borrowing from the Central and Commercial banks. Borrowing from the non bank members of the public often raises interest rates and reduces availability of credit to the private sector forcing a reduction in the sectors of consumption and investment expenditures.
Borrowing from the Central Bank increases money supply and may give rise to inflation and balance of payments problems.
Taxes can be used to change the effective demand in the economy and to affect consumption of certain commodities.

Difficulties in using fiscal policy
There are several problems involved in implementing fiscal policy. They include:

Theoretical problems
Monetarists and the Keynesians do not seem to agree on the efficacy of fiscal policy. Monetarists claim that budge deficits (or surpluses) will have little or no effect upon real national income while having adverse effects upon the rate of interest and upon prices.

The Net Effects Of The Budget
Unlike simple Keynesian view that various types of budgets have different effects, the empirical evidence is that the net effects of taxes and government expenditure are influenced by the marginal propensities to consume of those being taxed and governments expenditure.

The Inflexibility Of Government Finances
Much of the government’s finances is inflexible. One of the reasons for this is that the major portion ofalmost any departments budget is wages and salaries, and it is not possible to play around with these to suit the short-run needs of the government.

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