Fiscal policy means the use of taxation and public expenditure by the government for stabilization or growth. The government may offset undesirable variations in private consumption and investment by compensatory variations of public expenditures and taxes.
The following are the broad objectives of fiscal policy:
Significance of fiscal policy
Fiscal policy through variations in government expenditure and taxation profoundly affects national income, employment, output and prices. An increase in public expenditure during depression adds to the aggregate demand for goods and services and leads to a large increase in income via the multiplier process; while a reduction in taxes has the effect of raising disposable income thereby increasing consumption and investment expenditure of the people.
On the other hand, a reduction of public expenditure during inflation reduces aggregate demand, national income, employment, output and prices; while an increase in taxes tends to reduce disposable income and thereby reduces consumption and investment expenditures. Thus the government can control deflationary and inflationary pressures in the economy by a judicious combination of expenditure and taxation programmes. For this, the government follows compensatory fiscal policy.