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        Fiscal policy
WHEN the government makes use of its revenue and expenditure programmes (to achieve the above mentioned goals) and affects the aggregate level of demand for goods and services in the economy, then this action is essentially known as fiscal policy. Related to fiscal policy are deficits and surpluses. When the governmentís expenditure exceeds its revenue, then there is a fiscal deficit and the opposite of this is known is fiscal surplus.
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What is the difference between fiscal and monetary policies?
Renowned economist Keynes believed that taxes and expenditure decisions, that is fiscal policy, should be used to stabilize the economy. According to him, government should cut taxes and increase spending to bring the economy out of a slump, this kind of a policy action is known is expansionary fiscal policy. On the other hand, government should increase taxes and cut expenditure to bring the economy out of inflationary pressure, that is, it should follow a contractionary fiscal policy. The classical economists however believed that the government can affect the level of output, overall price level and interest rates by determining the level of money supply in the economy. When the central bank uses tools like CRR and repo rate to control the level of money supply to stabilize the economy then it is known as the monetary policy.
How does a fiscal policy affect the economy?
Aggregate demand, which is the total demand for goods and services in the economy, depends on three main variables- consumption, private investment and government spending. When the government increases its expenditure then it spurs the aggregate demand in the economy. A higher aggregate demand in turn will stimulate output, growth and employment. Whereas if the government lowers itís spending then it decreases the aggregate demand and hence slows down the growth of the economy.
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