Fiscal Policy

FISCAL POLICY
The purpose of this topic is to identify the needed policies when recession or inflation are present. Limitations of these policies are also studied. Nondiscretionary fiscal policies are presented. FISCAL POLICY Fiscal policy is the use of taxes and government spending to control the economic activity of a country. Such intent is explicitly stated in the Employment Act of 1946 and restated in the Humphrey-Hawkins Act of 1978. In 1981, the tax changes voted by congress were given the name of Economic Recovery Tax Act. This clearly shows that the government uses taxes as a method of controlling the economy. Along with spending, tax changes are what fiscal policy is. GOVERNMENT SPENDING INCREASE Government spending is an additional component of aggregate expenditure. The benefit of the multiplier effect can be derived as a one time increase in government spending to deal with a recession. Such was the case of the New Deal under Roosevelt. In the leakage-injection analysis, government spending is an injection and contributes to move the economy to a higher level of equilibrium. The Tennessee Valley Authority created in the 1930's was a combination of numerous major projects with thousands of new jobs. This new source of income, and thus aggregate expenditure, was a significant impetus for taking the economy out of the great depression. TAX INCREASE A tax increase reduces income, and thus, aggregate expenditure. If the tax increase is assumed to be a lump sum tax the aggregate expenditure will move downward in a parallel fashion. A tax increase may be warranted in the case of excessive demand causing inflation. In the leakage-injection analysis the tax increase is a leakage and is added to saving. In the late 1960's, a tax surcharge was enacted in the United States. Its purpose was to decrease the amount going to aggregate expenditure, i.e. create a negative multiplier effect, because the economy was experiencing an increasing inflation.

BALANCED BUDGET MULTIPLIER If the increase in government spending is just equal to the increase in taxes, the budget is balanced. A balanced budget with simultaneous increases in spending and taxes is not neutral but expansionary. The reason for an increase in output is that the taxes reduce both consumption and saving, and the reduction from the taxes is smaller than the increase from the additional spending. The value of the balanced budget multiplier is one. During most of the earlier part of this century, the various American administrations believed in balancing the budget. Any increase in spending had to be matched by an increase in tax revenue. Over that period and until 1930, the economy grew at a very healthy pace. But in the 1930's, a balanced budget with reduced spending in the recession contracted (i.e. rather than expanded) the economy further. KEYNESIAN FISCAL POLICY Keynes recommends to use an expansionary fiscal policy in the case of a recession: reduce taxes and increase spending. In the case of inflation, the opposite is recommended. All western governments have adopted measures which have explicitly called for government policies using taxes and spending to control economic activity. For the United States, that evidence is present in the Employment Act of 1946. FISCAL POLICY EFFECTIVENESS Expansionary fiscal policy may be less effective than needed if a crowding-out effect takes place as government prefers to finance spending through borrowings rather than taxes or new money. Fighting inflation may also be ineffective with reduced spending and increased taxation if the budget surplus is used to repay debt. The tax surcharge enacted in the late 1960's to combat inflation was not effective to stop inflation because the revenues were spent immediately in the Vietnam war effort. CROWDING-OUT EFFECT A crowding-out effect occurs when the government borrows: private investment is curtailed because funds are lent to the government rather than to more risky private borrowers.

Thus, the effect is to substitute government spending for potentially desirable private investment. Interest rates in the United States have been higher than those of other major western nations all through 1970-1980 period. One reason for these high interest rates is the large public debt which needs to be refinanced regularly. The Treasury must offer a high enough return to sell its issues. These high interest rates have been blamed for the slow growth. FISCAL POLICY LAGS Fiscal policy effectiveness may also be reduced by the presence of various lags or delays in the impact of fiscal policy. Recognition lag relates to the identification of the real problem. Administrative lag arises from the time it takes to enact the needed statutes. Operational lag results from how much time it takes for the effect of tax changes to be realized and be felt. Kennedy became president in 1960, in the middle of a mild slow down of the economy. He immediately proposed a tax cut according to Keynesian fiscal policy. However, the tax cut was not enacted until 1964 and the effects of the tax cut were not felt until several years later. By then, the economy was starting to experience inflation and the opposite policy was needed. NONDISCRETIONARY FISCAL POLICY Nondiscretionary fiscal policy refers to various ongoing programs of government spending and taxation. These are primarily for income maintenance purpose. They are usually rarely changed. They include social security, welfare and unemployment compensation. The payment of unemployment benefits is a typical example of nondiscretionary fiscal policy. The payments necessarily increase when the number of unemployed increases, and that is during an economic slow down. The payments necessarily decrease when the unemployed return to work with an economic recovery. AUTOMATIC STABILIZER The nondiscretionary fiscal policy acts as an automatic stabilizer for the economy because when the economy is in recession the payments tend to increase, while the collection of contributions decreases with lower income. When the economy is

prosperous the collections increase while the payments decrease. The surplus in prosperity and deficit in recession correlate with the needed policy and act to reduce (but not entirely correct) the existing economic condition. The largest unemployment benefits are paid out when unemployment is the highest. Thus, the benefits offset the decreasing income of those out of work. But the benefits are only a small portion of the income foregone: it is only a partial corrective measure. FULL-EMPLOYMENT BUDGET Since the automatic stabilizer of nondiscretionary fiscal policy creates deficits and surpluses which are insufficient, the size of the needed additional policy action must be determined. This is done with the help of the full employment budget, which calculates what would have been the budget surplus or deficit had the economy been at full employment. During the period 1970-1980, the American budget was in deficit. During this period of time, because of high rates of unemployment in the middle 1970's and early 1980's, the full-employment budget was in surplus (because had the unemployed worked in those years, the taxes they would have paid would have been larger than the spending). Thus, even greater actual budget deficits could have been defended. FISCAL DRAG The automatic stabilizer of nondiscretionary fiscal policy creates surpluses in periods of prosperity. Such surpluses may however be acting as an impediment or drag on further economic growth (if such growth is desirable). As part of the very desirable programs under the New Deal, social security was enacted. At that time, however, the retirees qualifying for payments were few while the contributions were collected on all salaries. At that time, social security prevented a faster recovery of the economy from the great depression. BUDGET DEFICIT Budget deficits occur when government spending exceeds government revenues. The U.S. federal budget has been in deficit

every year except one in the 1970's and 1980's. These deficits are essentially the product of Keynesian expansionary fiscal policies. However, in the 1980's the deficits grew even larger as a result of tax cuts inspired by supply side economics. Reducing budget deficits became then a political priority (e.g. Gramm-Rudman-Hollings Act). BUDGET PHILOSOPHY A budget philosophy of balancing the budget annually is not popular because it is procyclical (it makes business cycles worse). A functional budget philosophy (deficits whenever needed) is attributable to Keynesian employment theory (it has produced excessive debt). A cyclically balances budget philosophy is a third often proposed alternative. The most devastating effects of a balanced budget philosophy were learned from Hoover's administration efforts to balance the budget in the early 1930's in the United States (and similar efforts in Great Britain). The cut in spending contributed significantly to the severity of the great depression. PUBLIC DEBT The continuous budget deficits of the 1970'a and 1980's produced a very large public debt (in excess of $2,000 billions in early 1990's). Economists argued whether the debt affects current (crowding-out-effect) and future (necessity to repay the debt) economic conditions. The most undoubtful impacts were the need to service the debt (pay interest) and the external threat from foreigners who own a large proportion of the debt and thus are able to affect the exchange rate of the dollar. The stock market crash of October 19, 1987, was in part attributable to the large public debt (in the opinion of some economists). The reason for this was the need to offer higher interest rates to refinance the debt which caused inflation to pick up. Higher interest rates decreased the value of financial assets and prompted investors to sell, which drove prices further down. FISCAL POLICY AND POLITICS Fiscal policy is enacted by elected officials. Although economic stability is an important goal of the government, it is not its sole objective. National security, provision of public goods and services, and redistribution of income are just some of the other important considerations. Strong evidence suggests that

elected officials are often more concerned with getting reelected than just maintaining economic stability. FISCAL POLICY AND POLITICS Expansionary fiscal policies such as tax cuts or increased government spending are often implemented before elections to produce favorable economic indicators. Expansionary fiscal policies however tend to produce inflation, and soon after elections are over a contractionary fiscal policy has to be implemented. In addition, expansionary fiscal policies have a tendency to increase budget deficits. NET EXPORT EFFECT The net export effect reduces the effectiveness of fiscal policy. When an expansionary fiscal policy is implemented, net exports usually decline which decreases aggregate output. This decrease in aggregate output partially offsets the expansionary fiscal policy. When a contractionary fiscal policy is implemented, net exports will usually increase. This increase in aggregate output partially offsets the contractionary fiscal policy. INDEX OF LEADING INDICATORS The index of leading indicators is used to eliminate or shorten recognition lags. These indicators provide economists with a clue to where the economy is heading. None of the indicators alone can predict the future course of the economy. The eleven leading indicators are often averaged or indexed to provide a comprehensive forecast of the economy. An index which declines or increases three consecutive months or more is indicative that the economy is moving in a particular direction.

Objective of Fiscal Policy in Developing Economics In a developing economy where monetary policy alone cannot be effective due to the prevalence of under- developed money and capital markets. Fiscal policy along with monetary policy can play a vital and comprehensive role in accelerating the rate of growth and bringing about stability in the economy. According to Raja. J. Chellia "the implementation of the financial plan and the achievement of balances in real and money terms obviously will have to rely largely on fiscal measures."

From fiscal 1. 2. 3. 4. 5 6. 7. 1.

the foregoing discussion, we discuss the following objectives of a policy in a developing economy: Full employment Price stability Accelerating the rate of economic growth Optimum allocation or resources Equitable distribution of income and wealth Economic stability Capital formation Full Employment

Prof. Lerner narrating the significance of full employment, observed, "the economic gains from full employment are enormous. Full employment yields individual security. Security promotes progress. Full employment contributes to human dignity, weakens non functional discrimination". The first and foremost objective of fiscal policy in a developing economy is to achieve and maintain the full employment in an economy. In such circumstances, even if full employment is not achieved, the main motto is to avoid unemployment and to achieve a state of near full employment. Therefore, to reduce unemployment and under employment, the state should spend sufficiently on social and economic overheads. These expenditures would help create more employment opportunities and increase the productive efficiency of the economy. In this way, public expenditure and public sector investment have a special role to play in a modern state. A properly planned investment will not only expand income, output and employment but will also step up effective demand through multiplier process and the economy will march automatically towards full employment. Besides public investment, private investment can also be encouraged through tax holidays, can be made to encourage domestic industries by providing them training, cheap finance, equipment and marketing facilities. Expenditure on all these measures will help in eradicating unemployment and under-employment to a greater extent. Fiscal policy through its effect on consumption and in investment also influences the level of employment and income. It also influences propensity to save and can generate sufficient incentives for risk taking and innovation. Generally, funds are in-adequate at the disposal

of the government. Thus, public expenditure is financed through public borrowing. Moreover, government should follow a cheap money or low interest rate policy. Again, minds should be arranged from those with whom funds remain idle. In this context, Prof. Keynes made the following recommendation to achieve full employment in an economy. a) To capture the excessive purchasing power and to curb private spending. b) To compensate the deficiency in private investment through public investment. c) Cheap money policy or lower interest rates to attract more and more private entrepreneurs. Finally, a fiscal policy cannot be successful in achieving full employment if the public spending goes on wasting the growth of labour force. Since, in under developed countries, population grows at a very rapid rate, the objective of expanding employment opportunities cannot be fulfilled until growth of population is properly controlled. 2. Price Stability

There is a general arrangement that economic growth and stability are joint objectives for under developed economy to pursue. But it does not mean absolute constancy of price level. In a developing economy, economic instability is manifested in the form of inflation. They can be controlled by various other measures. But fiscal policy is most powerful one. In developing economies, inflation is a permanent phenomena where there is tendency to rise prices due to expanding form of public expenditure. As a result of rise in income, aggregate demand exceeds aggregate supply Capital goods and consumer goods fail to keep pace with rising income. Thus, these result an inflationary gap. The rise in price, rises demand for more wages. This further gives rise to repeated wage price spirals. If this situation is not effectively controlled, it may turn into hyper-inflation. In a real sense, the mild inflation is unavoidable in a developing economy rather desirable to some extent. It is unavoidable as government incurs more expenditure than income. It is desirable because a gradual rise in price stimulates production, investment and capital formation Thus, it is clear that mild inflation is necessary in a growing economy. But at the same time, if inflationary gap widens, the economy becomes distorted and it retards economic development.

Here, anti-inflationary fiscal policy plays an imperative role in such economics, involving reduction in public borrowings. In this regard, Prof. Musgrave observes that, "the objective of price level may be desirable to induce entrepreneurial optimism, or a more substantive raise may be needed to speed up transition to a war economy, and there are other times when a decline in price level may be useful. Anti-inflationary tax policy, however, faces certain limitations. These are: i) ii) iii) iv) Progressive taxation is only possible in direct taxation It will discourage investment and production Cut on certain expenditure made on social welfare is not desirable. Imposition of more taxation will reduce purchasing power in the hands of the common people.

Keeping in view all the facts in mind, fiscal measures should be supplemented with monetary measures to make them more effective. Moreover, efforts should be made to increase production especially of essential commodities. In order to counteract various fluctuations in the economy, government expenditure must be altered according to the need of time. In short, fiscal policy should try to remove the bottlenecks in various sectors of the economy. Moreover, it should strengthen physical controls of essential commodities, granting of concessions, subsides and protection in the economy. In short, fiscal measures as well as monetary measures go side by side to achieve the objectives of economic growth and stability. 3. To Accelerate the Rate of Economic Growth

Primarily, fiscal policy in a developing economy should aim at achieving an accelerated rate of economic growth. But a high rate of economic growth cannot be achieved and maintained without stability in the economy. Therefore, fiscal measures such as taxation, public borrowing and deficit financing etc should he used properly so that production, consumption and distribution may not be adversely affected. It should promote the economy as a whole, which in tarn help to rise national income and per capita income. In this connection, it is significant to quote the view of Mrs. Ticks, who observed. "now that

fiscal policy has been developed as an established economic function of a government, every country is anxious to tear its public finance in pursuit of the twin aims of stability and growth, but their relative importance is very differently regarded from one county to another. A steady rate of expansion will tend to reduce the violence of such fluctuations may occurs, a successful full employment policy will provide an atmosphere which is congenial for growth. Almost all the economists have recognized the significance of interdependent sectors, such as agriculture and industry, which should grow simultaneously. The development of agriculture sector depends on industrial development as the demand for agriculture products comes through industrial sector. Industrial sector is also complementary to agriculture as raw material is supplied by this sector. 4. Optimum Allocation of Resources

Fiscal measures like taxation and public expenditure programmers can greatly affect the allocation of resources in various occupations and sectors. As it is true, the national income and per capital income of under-developed countries is very low. Therefore, financing of development plans process a severe threat to the government of such under-developed economics. In order to gear the economy, the government can push the growth of social infrastructure through fiscal measures. Public expenditure, subsides and incentives, can favorably influence The allocation of resources in the desired channels. Tax exemptions and tax concessions way help a lot in attracting resources towards the favored industries. On the contrary, high taxation may draw away resources in a specific sector. Above all, direct curtailment of consumption and socially unproductive investment may be helpful in the mobilization of resources and the further check the inflationary trends in the economy. Sometimes, the policy of protection is a useful for the growth of some socially desired industries in an underdeveloped country 5. Equitable Distribution of Income and Wealth

It is needless to emphasise the significance of equitable distribution of income and wealth in a growing economy. Generally, inequality in wealth persists in such countries as in the early stages of growth, it concentrates in few hands. It is also because private ownership dominates the entire structure of the economy. Besides, extreme

inequalities create political and social discontentment, which further generate economic instability. It has been correctly stated that extreme inequalities in the distribution of income and wealth are detrimental to economic development in so far as they reduce the nutrition, health and living standards of the people. For this suitable fiscal policy of the government can be devised to bridge the gap between the incomes of the different sections of the society. To reduce inequalities and to do distributive justice, the government should invest in those productive channels which incur benefit to low income groups and be helpful in raising their productivity and technology. Therefore, redistribute expenditure should help economic development and economic development should help redistribution. In this regard Prof. W.W. Heller writes "redistribute finance appears to offer greater gains and involves less cost to under developed than to developed countries." In this manner, well- planned fiscal programme, public expenditure can help development of human capital which in turn possess positive effects on income distribution. Regional disparities can also be removed by providing incentives to back ward regions. A redistributive tax policy should be highly progressive and aimed at imposing heavy taxation on the richer and exempting poorer sections of the community. Similarly, luxurious items, which are consumed by the higher income section, may be subject to heavy taxation. Taxes and subsidies can change the degree of competition among various sectors. Distribution of land beyond a certain limit, among the landless farmers, will also offer the distributive pattern of land. 6. Economic Stability

Fiscal measures, to a larger extent, promotes economic stability in the face of short-run international cyclical fluctuations. These fluctuations cause variations in terms of trade, making the most favourable to the developed and unfavourable to the developing economics. So, for the purpose of bringing economic stability, fiscal methods should incorporate built-in-flexibility in the budgetary system so that income and expenditure of the government may automatically provide compensatory effect on the rise or fall of the nation's income. Therefore, fiscal policy plays a leading role in maintaining economic stability in the face of internal and external forces. The instability caused by external forces is corrected by a policy, popularly known as "tariff policy" rather than aggregate fiscal policy in the period of boom, export land import duties should be imposed to minimize the impact of international cyclical fluctuations. To curb the use of additional purchasing power, heavy import duty on consumer goods and luxury import restrictions are essential. During the period- of recession, government should undertake public work programmes through deficit

financing. To get rid of the international cyclical fluctuations, a contracyclical measure of deficit budgeting in depression and surplus budgeting in inflation is-called for. Other - distorting forces can also be met with compensatory taxation, public spending, pump-priming, public borrowing budgetary flexibility and debt management. 7. Capital Formation and Growth

Capital assumes a central place in any development activity in a country and fiscal policy can be adopted as a crucial tool for the promotion of the highest possible rate of capital formation. A newly developing economy is encompassed by a 'vicious circle of poverty on account of capital deficiency.' Therefore, a balanced growth is needed to breakdown the vicious circle which is only feasible with--higher rate of capital formation Once a country comes out of the clutches of backwardness, it stimulates investment and encourage capital formation. To quote UNO Report which observes that "a rocket or moonship must attain a definitely established speed of releaser before it can escape from the earth's gravitational field and become a free moving astronomical object." For rapid economic growth follows fiscal tools are better to use: i) ii) iii) iv) Raising the ratio of saving (S) to income (Y) by controlling consumption (C): Raising the rate of investment, Encouraging the flow of spending into productive way. Reducing glaring inequalities of income and wealth.

Therefore, fiscal policy must be designed in a manner to perform two functions as of expanding investment in public and private enterprises and by diverting resources from socially less desirable to more desirable investment channels. This policy will help to raise the level of aggregate saving -in the economy and create capital for bringing about a qualitative improvement in capital formation. Capital formation, however, can also be facilitated by taxation, deficit spending and foreign borrowing. In fact, fiscal measures of the government can diffuse a competitive spirit in the economy and may induce the private entrepreneurs to take active participation for mobilising resources at least in the long run. Role of Fiscal Policy in Developing Countries

The various tools of fiscal policy such as budget, taxation, public expenditure, public works and public debt can go a long way for maintaining frill employment without inflationary and deflationary forces in underdeveloped economics. Obviously, taxation and public expenditure are powerful instrument in the hands of public authority which greatly effect the changes in disposable income, consumption and investment. An anti-depression tax policy increases disposable income of the individual, promotes consumption and investment. This will ultimately result in increase in spending activities which in turn, increases effective demand of the people. On the country, during inflation, anti inflationary policy measure helps to plug the inflationary gap. During inflation, such measures are adopted which help to wipe off the excessive purchasing power and consumer demand. Tax burden is raised in such a manner as it may not retard new investment. Like taxation, public expenditure has a multiple effect on income, employment, and output. In inflation, public spending policy must aim at reducing the government spending. Reduction on unproductive channel proves very successful to curb inflationary pressures. While in depression, public spending is helpful to lift the economy out of the morass of stagnation. Additional doses of public expenditure with its multiplier and acceleration effect will neutralise the depressing effect of lower private spending and stimulate the path of recovery. Therefore, compensatory spending and pump priming are two tools which are greatly effective during the period of inflation and depression. However, Prof. Keynes had strong faith in spending on different public works as of roads, rail tracks, schools, parks, building, irrigation, canals, airports etc. He also favoured transfer payments such as interest on public debt, subsidy, pension, relict payment, unemployment insurance and other social security benefits etc. The main goal of fiscal policy in an under- developed country may be the promotion of the highest possible rate of capital formation without inflation. Stability is necessary for progress but the maintenance of stability does not require a fall in the rate of saving. Therefore, the fiscal operations of the government for promoting the economic development of less developed countries as of investor, as a stabilizer, as a saver and as a income redistributor. In the same fashion, subcommission of U.N. Department of Economic Affairs emphasised on the under-noted objectives of fiscal policy. They are: i) To provide incentive for desirable type of investment, which may encourage development of infrastructures.

ii) iii) iv)

To rise the total volume of saving available for economic development. To correct excessive or harmful inequalities in the -distribution of income and wealth. To promote export and reduce imports of unessential commodities.

Despite its limitations, fiscal policy as a means of promoting economic development and stability of developed and developing countries, plays the following crucial role: 1. To Mobilise Resources

The foremost aim of fiscal policy in under developed countries is to mobilise resources in private and public sectors. Generally, the national income and per capita income is very low due to low rate of saving. Therefore, the government of such countries, through forced saving, pushes the rate of investment and capital formation which in turn accelerates the rate of economic development It also undertakes the policy of planned investment in the public sector. Private investment has the favourable effect of increasing investment, the curtailment of conspicuous consumption and investment in unproductive channels can help to check the inflationary trend in the economy. Moreover, these countries face the problem of foreign capital, thus, remedy lies to raise the incremental saving ratio, the marginal propensity to save through public finance, taxation and forced loans. To some extent, progressive taxation, heavy duty on luxury imports, ban on the manufacture of luxury and semi-luxury goods are other measures which help mobilise the resources. Therefore, progressive taxation on windfall gains, on unearned income on capital gains, on expenditure and real estates etc. can go along way in public equitable distribution of wealth. The revenue from public enterprises and public borrowing are always inadequate. Similarly, deficit financing leads to inflationary tendencies, thus, limited scope. Still taxation is another tool for raising revenues to finance development activities but it has its own problems of compulsion. Even then, it helps in achieving the growth with stability of a large scale investment that is made in productive channel. 2. To Accelerate the Rate of Growth

Fiscal policy promotes to accelerate the rate of economic growth by raising the rate of investment in public as well as private sectors. Therefore, various tools of fiscal policy as taxation, public borrowing, deficit financing and surpluses of public enterprises should be used in a combined manner so that they may not adversely affect the consumption, production and distribution of wealth. In order to achieve balanced growth in different sectors of the economy, the most fruitful line of advance lies along he path of balanced development of agriculture and industry. In short, investment in basic and capital goods industries and in social overheads is the pillars of economic development in an underdeveloped economy. Thus, top priority to such investment should he given to accelerate all round growth of an economy. 3. To Encourage Socially Optional Investment

In underdeveloped countries, fiscal policy encourages the investment into those productive channels which are considered socially and economically desirable. This means optimal investment which promotes economic development and avoids wasteful and unproductive investment. In short, aim of the fiscal policy should be to make investment on social and economic overheads such as transportation, communication, technical training, education, health and social conservation. They tend to rise productivity and widen of the market, thus external economics. At the same time, unproductive Investment is checked and diverted towards productive and socially desirable channels. 4. Inducement to Investment & Capital Formation

Fiscal policy plays crucial role in underdeveloped countries by making investment in strategic industries and services of public utility on one side and induce investment in private sector by giving assistance to new industries and introduce modern techniques of production. Thus, investment on social and economic overheads are helpful in increasing the social marginal productivity and thereby raising the marginal productivity of private investment and capital formation. Here, optimum pattern of investment can also go a long way to yield fruitful results of economic development. As economic development is a most dynamic process which involves changes in the size and quality of population, tastes, knowledge and social institutions. Keeping all factors in mind, if social marginal productivity in social desirable projects is low, fiscal policy should be framed to raise social marginal

productivity and to divest resources to the productive charnels where the social marginal productivity is highest. 5. To Provide More Employment Opportunities

In developing countries, population grows at a very fast rate. Thus, the aim of fiscal policy in such countries is to make high dose of expenditures which are helpful to increase employment opportunities and to reduce underdevelopment and disguised unemployment specially in rural areas. The state should make effort to introduce community development programmes involving more labour and less capital per head- Besides, steps should be taken to encourage private enterprises through tax concessions, tax holidays, cheap loans and subsides etc. This process will encourage domestic industries and helpful not only in eradicating unemployment but generating more employment opportunities. Moreover, the state should provide more social amenities with a greater stress on family planning. In case, population is not controlled, the objective of increasing employment opportunities has no meaning. 6. Promotion of Economic Stability

Still another role is played by the fiscal policy in developing countries is of maintaining seasonable internal and external economic stability. Generally, a developing country is prone to the efforts of international cyclical fluctuation. Such countries mainly export primary products and import manufactured and capital goods. However, in order to minimise the efforts of international cyclical fluctuations fiscal policy should be viewed from a longer perspective. It must aim at the diversification of all sectors of the economic. For bringing balanced growth and reducing the effects of cyclical fluctuations, a contracyclical policy of deficit budgeting in depression and surplus budgeting in inflation are most suitable measures. In a recession, public works programme through deficit financing brings fruitful results. No doubt, injection of additional purchasing power would tend to inflationary pressures which can be controlled with preventative measures On the contrary, such a policy, should be supplemented by appropriate monetary measures. 7. To Check Inflationary Tendencies

Inflationary tendencies is one of the main problems of developing countries as these countries make heavy doses of investment for their development activities. Thus, there is always an imbalance between

the demand for and supply of real resources. With additional injection of purchasing power, the demand rises but supply remains inelastic on account of its structural rigidities market imperfections and other bottle necks which in turn leads to inflationary pressures on the economy. Aggregate demand as a result of rise in the income of the people exceeds the aggregate supply. Capital goods and consumption goods fail to keep pace with the rising income. Rising prices lead to a rise in demand for higher wages. In a developing economy a mild inflation is unavoidable and desirable to stimulate production but galloping inflation distorts the economy. Fiscal policy, therefore, aims at counteracting inflationary practices in such developing economic through cut in the public expenditure, raising the level of direct taxation and incurring public debt. At the same time, fiscal role of the state should also include the removal of structural rigidities, physical control of essential products, granting of loans and subsides, protection of essential goods industries and planning of all sectors. Besides, it is imperative that tax structure should be such so that it may not hamper private investment adversely. Above all, fiscal measures should be supplemented with monetary measures, so that both collectively fight against inflationary tendencies and they do not create confusion over the objectives of all round growth and economic stability.