Fiscal Policy,

Budget Deficits
and
the Government
Debt
Dr. Shylajan, C.S

Topics of Discussion

Fiscal Policy and Economics Growth

Fiscal Policy and Stabilization
The Fiscal Policy and Fiscal Instruments
Fiscal policy impacts on AD
Crowding Out
Central Government Budget
Government Budget Policy
Measures of Deficit
Methods of deficit financing
Government Borrowings
Some Numerical Problems

The Fiscal Policy and

Fiscal Instruments

Fiscal Policy:
The use of government spending
and taxation, as opposed to
monetary policy (interest rates
and money supply), to try to
influence the level of economic
activity.

The Fiscal Policy and

Fiscal Instruments

Fiscal Instruments and impacts on target

variables
How does fiscal policy instruments
influence all major real macro variables?
Target variables:
Disposable income,
Aggregate consumption expenditure,
Saving and investment,
Imports and exports

The Fiscal Policy and

Fiscal Instruments

How fiscal policy influence

aggregate demand?

Budget policies:
Balance budget policy,
Deficit budget policy and
Surplus budget policy

Types of Fiscal policy

Automatic stabilization Vs
Discretionary fiscal policy
Automatic stabilization: Suppose
slow down phase of the economy..
government spending automatically
increases in the form of benefits to the
vulnerable sections of the society
(transfer payments for instance)AD
may increase automatically

Types of Fiscal policy

Period of boom: number of

eligible beneficiaries shrinks
government spending
automatically slow down the
growth of AD.
So stabilization takes place
automatically

Types of Fiscal policy

Discretionary fiscal policy: govt takes

deliberate changes in tax, expenditure etc.
Recall what is expansionary fiscal policy
An expansionary fiscal policy : lowering
taxes and higher government spending
Recall what is contractionary fiscal policy
A contractionary fiscal policy : raising
taxes and cutting government spending.
In which period we follow these policies?

The Fiscal Policy and

Fiscal Instruments
1.
2.

Government spending
Tax policy

Implementation thru budget

Governments
Expenditure and Receipts

Revenue Expenditure (RE)

1.

Consumption expenditure
Interest Payments
Transfer Payments (food and fertilizer subsidy,
unemployment benefit, pension etc)

2.
3.

Capital Expenditure (CE)

Amount used during a particular period to acquire or improve long
term assets.

Example: Govt spending on new Roads, Dams,

new machines and equipments etc

Total Expenditure = RE + CE

Governments
Expenditure and
Receipts
In India, Revenue expenditure

accounts for more than 80 % of

total government expenditure
Within revenue expenditure, more
than 35 % of central govts
expenditure goes towards payment
of interest on government debt
20% on Transfer Payments

Government Receipts:
Tax and Non Tax
Revenue
Revenue Receipts (RR)
1. Tax Revenue (net to centre)
2. Non-Tax revenue (lotteries etc)

Capital Receipts (CR)

1. Recovery of Loans
2. Other Receipts (receipts from disinvestments)
3. Borrowings and other liabilities

Total Receipts = RR + CR

Capital Receipts

Loans raised by the Government from

the public (called market loans);

Borrowings by the Government from

the Reserve Bank of India (RBI)

Loans received from foreign

governments and bodies; and

Capital Receipts

Recoveries of loans granted by the

Union Government to State
governments, Union Territories and
other parties.

Proceeds from divestment of

government equity in public
enterprises.

Tax and Non Tax

Revenue
Non-Tax revenue:
Interest and dividends received from its
various investments in public sector
undertaking, fees etc

Lotteries and user charges for State govts

Government's own receipts include tax

revenue, non tax revenue, recovery of loans
and receipts from public sector
disinvestments

Tax Revenue

Direct Tax

Tax on Income and related Assets

Direct taxes affect both aggregate demand
and aggregate supply. How?

Indirect Tax
Tax on Commodities and Services.
Customs and excise duties

Direct and indirect tax

A

direct tax is collected directly

by government from the
persons on which it is levied.

An

indirect tax on goods and

services tax is collected from
the person who bears the tax by
intermediaries and the proceeds
passed on to government.

Tax Structure

Progressive : people with higher

levels of income are imposed with
higher rate of taxes. Direct taxes in
India is progressive in nature
Proportional: same percentage of
tax is paid
Regressive: a tax in which the poor
pay a larger percentage of his/her
income than the rich (incidence of
tax is higher on poor)

Measures of Deficit of
the Central
Government:
Fiscal Deficit: Difference

between government expenditure

and governments own receipts.

Fiscal Deficit = Total Expenditure

- (Revenue Receipts + Recoveries
of Loans + Other Receipts)

Measures of Deficit of
the Central
Government:
Revenue Deficit: Revenue Expenditure
minus Revenue Receipts

Monetized Deficit: When the deficit is

being financed from borrowing from
RBI it is called MD. This will result in
increase in money supply

Primary Deficit = Fiscal Deficit Interest Payments

Numerical Problems
Q1.
(a) Compute Revenue Deficit
(b) Fiscal Deficit and
(c) Primary Deficit from Indian
Budget Estimates
see the data in the next slide

Indian Budget- (Rs in

Crores)
Revenue Receipts 253935
Revenue Expenditure 366227
Non-Plan Expenditure 302708
Plan Expenditure 111455
Recoveries of Loans 34191
Other Receipts
3151
Interest Payments
117804

 Revenue

deficit: Rs.
112292 Cr
Fiscal deficit: Rs.153637 Cr
Primary deficit:Rs.30414 Cr

Numerical Problems
Q 2. Compute

(c)

Revenue deficit
Fiscal deficit and
Primary deficit from the data.

see data in the next slide

(a)
(b)

Numerical Problems
Revenue Receipts 309322
Recovery of Loans 27100
Other receipts 4000
Non-plan revenue expenditure 293650
Interest Payments 129500
Non-plan capital expenditure 38589
Plan revenue expenditure
91843
Plan capital expenditure
53747

 Revenue

deficit: Rs. 76171

Cr
Fiscal deficit: Rs. 137407
Cr
Primary deficit:Rs. 7907 Cr

How does Government

finance Fiscal Deficit?
Borrowing from the Central Bank
(Money financing results in Inflation)
Borrowings from the Domestic
Market
Borrowing from Abroad
By Increasing Taxes (result:
Disincentives)

Trends in gross fiscal deficit

of central govt: India (% of
GDP)
1986-87 7.57
1990-91 6.61
1991-92 4.72
1993-94 6.43
1997-98 4.81
2001-02 6.20
2005-06 4.30
2006-07 3.5
2008-2009 3?

Trends in gross fiscal

deficit of central govt:
India

2002 onwards, gross fiscal deficit

is in declining trend.

There is a sharp fall in borrowings

for capital expenditure.

Topics of Discussion

How does fiscal policy work?

How does fiscal policy affect aggregate
demand?
Discretionary and Automatic stabilization
Fiscal Policy and Efficiency
ICOR
When is Government Expenditure
Productive?

Topics of Discussion

Economic impact of fiscal deficits

and debt

Fiscal Policies in India

The Interaction of Monetary and

Fiscal Policies

Crowding out
controversy

Deficit financing----net injection into

the economy
An increase in AD
A rise in general price level
If govt spends on remote-return
projects, results in increase in money
income without increase in output.
Sets an inflationary trend

Crowding out
controversy

To control inflation, central bank

intervenes
It adopts tight monetary policy
(Then what happens?)
Tightens the credit availability
and raises the r
Rise in r finally crowds out
private investment

Question for
discussion

 Do

you think fiscal deficit is

important in economies like
India? If yes, Why?

What

are the views against

and for fiscal deficit financing?

Suppose the government has

the option of stimulating the
economy through
(a) an increase in government
expenditure and
(b ) a reduction in taxes.
Other things being equal,
which will have a larger impact
on GDP and why?

Thank you