CHAPTER 7 : FISCAL AND MONETARY POLICIES

7.1 Fiscal Policy

(A) Meaning and Importance of Fiscal Policy

i) Introduction: Fiscal and monetary policies are the two important instruments in the hands of the modern public authority. During and after the Second World War period these have gained ever-increasing importance in macroeconomic analysis and policy. It was Keynes who first recognized the need of regulating private enterprise economy. In his General Theory (1936) he asserted that large-scale public expenditure is to be made from time to time to avoid cyclical fluctuations in economic activities and to maintain high levels of employment and income. Since then fiscal policy has come into prominence. Almost all modern governments today collect resources to the extent of 30 percent or more of the national income and spend this on a variety of economic activities. Classical economists before Keynes were opposed to large-scale fiscal policy and government expenditure. They held a simple belief: "That government is best which taxes the least or which spends the least." This is because they were of the view that government spending causes unnecessary intervention in private economic activities. They believed that the free enterprise system is a self-equilibrating one and public intervention will only cause disturbances in its smooth working. But Keynes opposed such a view. He pointed out that throughout the 19^th century, western free enterprise economies have suffered frequent problems of cyclical fluctuation. The recent experience during the Great Depression (1929-33) is a flagrant example of it. During the Depression, output and employment levels fell by 40 percent for a prolonged time.

The modern public authority has a responsibility of promoting public welfare. It cannot play a passive role during such major economic crises. Again the classical school generally suggested that if there is any problem of inflation or deflation then public authority instead of directly intervening in the form of fiscal policy can use monetary policy. This basically concerns the regulation of money supply. It may be said that the economy can be kept in order with the help of the monetary policy which operates indirectly. Keynes, however, opposes this argument. It can neither be effective nor adequate during the periods of widespread unemployment and such other major crises.

ii) Budgetary Policy: This relates to two important implements: government expenditure and taxes. The idea of collecting taxes is so that the government can carry out expenditure on various public facilities.

a) Revenue and Capital accounts: Modern public authorities have been popularly making use of fiscal policy. It is planned and implemented through annual budgets of the governments. A budget is an estimated or anticipated account of government receipts and expenditure in the next financial year. It is discussed and voted (for or against) in the legislature, in the Congress or Parliament. It is implemented by executives such as ministers or secretaries.