What Is a Fiscal Policy?

The economy can be stable if the problems of excess and deficient demand are tackled. This situation can be handled by the government through a revenue expenditure policy. This policy incorporates two policies known as fiscal and monetary policy. Let’s discuss fiscal policy in depth initially. Fiscal policy is mainly used to combat inflationary and deflationary gaps. These gaps arise due to excess demand and deficient demand.

Fiscal Policy

This policy is related to the revenue and expenditure of the government. It is also termed the budgetary policy of the government. The main objective of this policy is to stabilize the economy by rectifying the situation of excess demand and deficient demand. Excess demand causes an inflationary gap, and deficient demand causes a deflationary gap.

In this blog, we have enlisted components of fiscal policy for you that can help you clearly understand the concept of fiscal policy without much hindrance:

In the following discussion, we will discuss the principal components of fiscal policy. In addition to each component, we are describing the methods used to correct the situation of excess demand and deficient demand.

Government Expenditure

This is the primary component of fiscal policy. The government suffers from various kinds of outlays. Some of these expenditures we are describing as follows:

Expenses on public works programs include the composition of roads ,dams ,bridges etc. Expenses on education and public welfare programs Expenditure in the defence sector and in the maintenance of law and order. The government spends on various types of subsidies related to producers. These are done to enhance production.

By altering these expenditures, the government can handle the situations of excess demand and deficient demand. To illustrate, governments reduce their expenditure during excess demand while expenditure increases in order to tackle a deficiency of demand. The spending rise is an attempt to calculate the flow of income in the economy. Likewise, the reduction of expenditure is done to cut down on the flow of income in the economy.


Household pay to the government is known as tax. If the government increases the tax burden on households, their disposable income will be reduced. As a result, the AD is reduced or excess demand is managed. On the flip side, by lowering the tax, the government increases the disposable income of households. Hence, AD is raised and demand is handled.

Borrowing by the government

The government borrows from the public and uses this collection to pay off public debt. In a state of deficient demand, the government lowers its borrowing from the public. so that liquidity will be maintained and aggregate expenditure remains high. On the other hand, during a situation of excess demand, the government borrows more from the public. Also, their offers capture interest rates. As a result of this, aggregate expenditure is reduced and excess demand is controlled.

Borrowing from RBI(the central bank)

The government also borrows from the RBI. This is also an essential factor in fiscal policy. The government increases this borrowing to confront the deflationary and reduce the inflationary gap. If the borrowing is greater, then it will result in greater liquidity in the economy. Higher borrowing is required to correct the deflationary gap( deficient demand ). On the contrary, if borrowing is reduced, the liquidity in the economy will also be reduced. Lower borrowing is imperative to correct the economy’s inflationary gaps (excess demand ).


Fiscal Policy in India Is Formulated by?

Ministry of Finance develops the fiscal policy.

Which policy deals with the taxation and expenditure decisions of the government?

Fiscal Policy.

What fiscal measures would you recommend to correct deficient demand?

Following fiscal measures are recommended to correct deficient demand :

  • The government should step up its expenditure on public work programs, education and public welfare. Also government should give subsidies to the producers, defence and law & order sectors. Higher government expenditure acts like an injection into the circular flow of income in the economy.
  • The government should reduce the tax burden on households so that they are left with greater cash balances. Higher cash balances with the people lead to a higher level of AD.
  • The government should raise more funds from the RBI so that there is a greater flow of liquidity in the economy. Higher liquidity implies a higher level of AD.
  • The government should plan a cut in public borrowing so that people are lift with greater liquidity. Greater cash balances imply higher AD.

Briefly, deficient demand is corrected when the government steps up its own expenditure and ensures that cash balances with people are raised.

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