Document1 - Microsoft Word age Layout References Mailings Review View Body) 11 - AA " 2.E2. I bccD. . U abe x, X A. a. i Normal 1 No Spaci... Heading 1 Heading 2 Title Subtitle Subtle E Font Paragraph Styles A case study: An important way the government affects the economy is through the adoption of appropriate fiscal policy. The fiscal policy refers to taxation and expenditure decisions of the government Before Keynes it was bell=ieved that the government budget should preferabily be balanced, at is. revenue collected through taxes should be equalto the expenditure made by the government. keynes showed that balanced budget is not good under all circumstances. He advocated that times of depression, deficit budget should be made to get the economy out ofit and to climinate involuntary unemployment. In case of deficit budget the govemment expenditure excecds revenue collected through taxes. The budget deficit arises when the government increases its expenditure without raising taxes or it arises when taxes are reduced without cutting back an expenditure. Therefore, the policy of budget deficit represents expansionary fiscal policy, The budget deficit raises aggregate demand Bnd leads to the jnerease in national income and employment. To meet the budget deficit, the government borrows from the banks and the public and pays folerest lo them. bb This raises debt burden of the government. The borrowing by the government increases the demand forloanable funds and leads to rise in rate of interest. The higher interest rate discourages private investment. It is therefore claimed that government borrowing to finance budget deficit crowids our some private investment so that net effect of budget deficit on expansion n outpul and employment is small. We will explain in detail in a subsequent chapter how farthis crowding-out effect is significant. However, to avoid borrowing and rise in public debt, the alternative way to finance the budget deficit is printing of money by the government. The dunger of financing budget deficit through printing of money is that it may lecad to inflation in the economy. The implications of different ways of financing budget deficit will be discussed in detail in a later chapter. On the contrary, when there is high inflation in the economy the government can check it by reducing its expenditure or raising taxes and in this way make a surplus budget. This will tend to reduce aggregate demand which will help in controlling inflation. Thus fiscal policy is an important instrument used by the government to change the level of aggregate demand and thereby affect income emnlosment and prices Monetary policy? * English (India) search o ai W