BYMANGESH PATIL

JAYESH BHANDARIANKUSH MOGAL

SHREEGANESH SARVE

Fiscal policy as a means to prevent Recession

DEFINITION

Fiscal policy refers to the taxation, expenditure and borrowing by the Government.

It is the most important instrument of government intervention in the economy.

Three basic objectives –1. Ensuring price stability2. High output and employment level3. Economic growth

Recession

The fall in general price level is called ‘Recession’.

This is a phase of a Business cycle which succeeds the phase called ‘Peak or Maturity’.

This phase is characterized by following points-

High rate of unemploymentSubstantial decrease in GNPFall in pricesUnderutilised excess capacity

Illustrations of recessions

Great depression(1929-1933) In US, Unemployment rate -3.2 to 25 % GNP –Fall by 30 % Recessionary situations in 1964,1984Japan – 1990s period of sustained recession (huge amount of savings)World recession 2008 (sub prime crisis)Eurozone crisis

Process of Recession

Peak Period in the EconomyWave of pessimism amongst investors

regarding the mechanism of profit making in the market.

Lesser investmentsLow aggregate expenditure and demandLow national output Cyclical unemploymentDepression

Graphical presentation of recession

Need of fiscal policy in tackling recession

Superiority of fiscal policy to monetary policyMonetary policy depends upon interest ratesUnemployment and pessimism in economy Direct effect on income, employment,

expenditure and output.‘Attack is the best defense’-Maintain full

employment with gradually rising price level

Expansionary fiscal policy

Discretionary fiscal policyDeliberate change in government expenditure and

taxes to influence national output and pricesNon-discretionary fiscal policyAutomatic stabilizers-Built-in tax or expenditure

mechanism which automatically increases aggregate demand in recessionary times.

1. Personal income tax2. Corporate income tax3. Transfer payments(unemployment compensation)4. Welfare benefits

GOVERNMENT EXPENDITURE TO THE RESCUE

• Discretionary fiscal policy Increase in expenditure by starting public works.

Ex.- Building roads, dams, ports, irrigation works, electrification of new areas etc. Two effects

Direct effect:- Increase in income of material suppliers & labors

Indirect effect:- Increase in disposable income and consumption expenditure

-Greater output, income and employment - increase in transaction demand for money

Graphical presentation

Reduction in taxes

Indirect effectIncrease in disposable income and hence

marginal propensity to consumeE.g. Government reduces Rs. 200 crores of

tax people have Rs.150 crores as disposable income (MPC=.75)

Keepin Govt. Expenditure constant, an upward shift in C+I+G curve.

Decreased taxes =Increase in income, output, employment

Illustrations

1964-US president John F. Kennedy waived off $12 billion worth of tax liabilities.

1984-US prez Ronald Reagen ordered reduction in taxes

Multiplier effect

Tax multiplier (Change in Taxes × MPC/ 1-MPC)Government expenditure multiplier (1/1-MPC)Tax multiplier < Govt. Expenditure multiplier

Other measures

Encouraging personal savings and investment(Retained profits reinvesting in the economy)

Encouraging entrepreneurs

THANK YOU