Fiscal policy as a means to prevent Recession

BY MANGESH PATIL JAYESH BHANDARI ANKUSH MOGAL SHREEGANESH SARVE

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 stability 2. High output and employment level 3. 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 unemployment Substantial decrease in GNP Fall in prices Underutilised excess capacity

Illustrations of recessions
Great depression(1929-1933)

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

Process of Recession
Peak Period in the Economy

Wave of pessimism amongst investors regarding the

mechanism of profit making in the market. Lesser investments Low aggregate expenditure and demand Low national output Cyclical unemployment Depression

Graphical presentation of recession

Need of fiscal policy in tackling recession

Superiority of fiscal policy to monetary policy

Monetary policy depends upon interest rates

Unemployment 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 policy Deliberate change in government expenditure and taxes

to influence national output and prices Non-discretionary fiscal policy Automatic stabilizers-Built-in tax or expenditure mechanism which automatically increases aggregate demand in recessionary times. 1. Personal income tax 2. Corporate income tax 3. 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 effect

Increase in disposable income and hence marginal

propensity to consume E.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