Objectives of Fiscal Policy

Objectives of Fiscal Policy

Professor Lind Holm in his book ‘Introduction to Fiscal Policy’, laid down the following four main objectives of fiscal policy 

                  (i)            The achievement of desirable prices,

                (ii)            The achievement of desirable consumption level,

               (iii)            The achievement of desirable employment level, and

              (iv)            The achievement of desirable income distribution.

The objectives of fiscal policy differ in different countries according to their economic conditions and needs.  That is why, the fiscal policy is known as the process of shaping taxation and public spending with a view to achieve certain specific objectives.  In advanced countries, the objectives of fiscal policy is to increase aggregate demand by stimulating consumption function, whereas in underdeveloped countries, the consumption of luxurious items has to be discouraged in order to encourage saving for increasing the rate of economic development.  In economically advanced countries, the goal of fiscal policy may be to reduce the inequality of income in order to check under consumption; whereas in a backward economy, unequal distribution of wealth may be allowed rather encouraged for promoting capital formation.  Though the objectives are controversial but they are grouped into three:

1.    To achieve full employment without much inflation,

2.    To dampen the swings of business cycle and promote moderate price stability in the economy,

3.   To increase the potential rate of growth with consistency if possible without interfering with attainment of other objectives of society.

1. Full-Employment: An economy can attain the potential rate of growth when the full-employment rate of capital formation, rate of technological change, the improvement in levels of skill and education, and increased availability of other factor units are achieved.  Total spending (C + I + G) must at all times keep pace with rising national income (Y), or otherwise the unemployment will develop.

2. Price Level Stability: The maintenance of a reasonably stable general price level is also regarded as a major objective of fiscal policy.  A decline in the general price level is incompatible with the maintenance of full employment and would generate bitter labour strife, as well as injuring debtors.  Inflation – a rising price level – does offer the limited advantage of aiding investment.  However, a continued inflation of any magnitude produces is undesirable. 

Stability in the price level does not require stability of prices of all individual commodities.  Commodities experiencing more than average increases in productivity will decline in price; and those with little change in productivity will rise as money wages rise to reflect the higher productivity in the other fields.  If money wages keep pace with productivity in manufacturing, the general price level will rise slowly.

As full employment is approached unions may tend to push money wages up faster than productivity and prices will rise.  Some trade off between the two objectives may be necessary, that is, society may have to accept some unemployment in order to avoid inflation.  One study concludes that 4% unemployment is necessary if the increase in the general price level is to be held to 1½ percent; with 3 percent unemployment the price level increase will be 2½ percent or more.

3. Sustained Economic Growth: The third goal of fiscal policy is to increase the potential rate of economic growth.  A higher rate of economic growth requires a higher rate of capital formation and a higher S/Y ratio at full employment. But additional saving requires reduction in consumption.  It is a choice between present and future consumption.