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Anti Inflationary Budgetary Policy Analysis

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Published: Mon, 20 Nov 2017

  • NIDHI GUPTA

WHAT IS ANTI INFLATIONERY BUDGETARY POLICY? EXPLAIN ITS PROS AND CONS .

BUDGETARY POLICY

Budget is the planned expenditure of the government programs and the expected revenues from the taxes. A budget is a quantitative expression of a plan for a defined period of time. It may include planned sales volumes and revenues, resource quantities, costs and expenses, assets, liabilities and cash flows. It expresses strategic plans of business units, organizations, activities or events in measurable terms.

BUDGETARY POLICY DEFINATION

Budgetary policy refers to the government attempt to run a budget in equilibrium or in surplus. It aims to reduce public debt. The purpose of the policy is to provide the framework for ensuring responsible monitoring , reporting and controlling of financial performance .

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OBJETIVES

  1. FULL EMPLOYMENT – It is very important objective of budgetary policy . Unemployment reduces the level of production, and hence the level of economic growth. It also creates many problems to the unemployed people in their day-to-day life. So, countries try to remove unemployment and attain full employment. Full employment refers to that situation, where there is no involuntary unemployment in the economy. To attain this objective, government tends to:
  • Increase its spending
  • Lower the personal income taxes
  • Lower the business taxes, or
  • Employ a combination of increasing government spending and decreasing taxes

However, in practice, it is difficult to achieve full employment. As the factor markets are not perfect, factor units may lose their jobs and may not get the new jobs immediately.

  1. PRICE STABILTY – : Both sharp rise and sharp fall in general price level are not desirable. It is because sharp rise in prices makes many goods and services unaffordable to the consumers whereas sharp fall in prices discourages the producers to produce goods and services. So, price stability is desirable. However, it should be noted that the principle that general price level should be reasonably stable is generally accepted, the determination of exact trends which are most satisfactory from the stand point of welfare of society is difficult.
  2. ECONOMIC GROWTH – It is also an important objective of budgetary policy . By the higher rate of economic growth, the problem of unemployment can also be solved. However, it may create some problems in the maintenance of price stability. The developed countries, like USA, UK, Japan, etc. give attention to the relationship of actual growth rate to the potential growth rate permitted by the consumption – saving ratio, technological considerations and other factors. The less developed countries give emphasis to the increase in the potential growth rate as well as the relationship of the actual and potential growth rate.
  3. RESOURCE ALLOCATION – : Resource allocation refers to assigning the available resources of the economy to the specific uses chosen among many possible and competing alternatives. It gives answer to what to produce and how to produce-questions of the economy. Budgetary policy should ensure the optimum allocation of the resources. It should divert the resources from unproductive sectors to the productive sectors of the economy. It is the long-run objective of the government. The emphasis of the government upon the full employment, price stability and economic growth should not overshadow the resource allocation goal.
  4. INCREASE IN SAVINGS – : This policy is also used to increase the rate of savings in the country. In the developing countries rich class spends a lot of money on luxuries. The government can impose taxes on them and can provide the basic necessities of life to thepoor classon low rate. In this way by providing incentives, savings can be increased.
  5. EQUAL DISTRIBUTION OF WEALTH – : Budgetary policy is very useful for the achievement of equal distribution of wealth. When the wealth is equally distributed among the various classes then their purchasing power increases which ensures the high level of employment and production.

FUNCTIONS OF BUDGETARY POLICY

1) ALLOCATION – The first major function of budgetary policy is to determine exactly how funds will be allocated. This is closely related to the issues of taxation and spending, because the allocation of funds depends upon the collection of taxes and the government using that revenue for specific purposes. The national budget determines how funds are allocated. This means that a specific amount of funds is set aside for purposes specifically laid out by the government. This has a direct economic impact on the country.

2) DISTRIBUTION – Whereas allocation determines how much will be set aside and for what purpose, the distribution function of fiscal policy is to determine more specifically how those funds will be distributed throughout each segment of the economy. For instance, the government might allocate $1 billion toward social welfare programs, but $100 million could be distributed to food stamp programs, while another $250 million is distributed among low-cost housing authority agencies. Distribution provides the specific explanation of what allocation was intended for in the first place.

3) STABILIZATION – Stabilization is another important function of budgetary policy in that the purpose of budgeting is to provide stable economic growth. Without some restraints on spending, the economic growth of the nation could become unstable, resulting in periods of unrestrained growth and contraction. While many might frown upon governmental restraint of growth, the stock market crash of 1929 made it clear that unfettered growth could have serious consequences. The cyclical nature of the market means that unrestrained growth cannot continue for an indefinite period. When growth periods end, they are followed by contraction in the form of recessions or prolonged recessions known as depressions. Budgetary policy is designed to anticipate and mitigate the effects of such economic lulls.

4) DEVELOPMENT – The fourth major function of budgetary policy is that of development. Development seems to indicate economic growth, and that is, in fact, its overall purpose. However, budgetary policy is far more complicated than determining how much the government will tax citizens one year and then determining how that money will be spent. True economic growth occurs when various projects are financed and carried out using borrowed funds. This stems from the belief that the private sector cannot grow the economy by itself. Instead, some government input and influence are needed. Borrowing funds for this economic growth is one way in which the government brings about development. This economic model developed by John Maynard Keynes has been adopted in various forms since the World War

PROS AND CONS

1. AGGEREGATE DEMAND – One of the key benefits of budgetary policy is the ability to influence aggregate demand. During economic contractions, increases in government spending and reduction in taxation can increase the level of economic output and support employment. Conversely, during economic expansions, decreases in government spending and increases in taxation can slow down an overheating economy. One drawback of budgetary policy is the time lag between selecting a fiscal policy and influencing the economy due to the need for Congressional approval.

2. THE PRICE LEVEL – Budgetary policy also carries implications with respect to the price level in the economy. Stimulating aggregate demand by expansionary budgetary policy will cause the price level to increase, whereas contraction in budgetary policy will cause it to decrease. This is because the level of output, in the long run, is determined by the supply of factors of production, not by the level of aggregate demand. The risk of inflation is of central concern when conducting expansionary budgetary policy.

3. INTEREST RATE AND CROWDING OUT – Government spending and taxation choices will have an impact on the level of interest rates prevailing in the economy. In the case of expansion in budgetary policy, the government must borrow and compete for loans with private borrowers such as individuals and corporations. This results in higher interest rates and a reduction in private investment. Consequently, policymakers must weigh the drawbacks of reduced private output when pursuing expansion in budgetary policy.

4. THE EXCHANGE RATE – The exchange rate is another variable affected by budgetary policy choices. When the government engages in expansion in budgetary policy, interest rates rise and cause the exchange rate to appreciate. This results in the country’s exports becoming more expensive to foreigners and imports becoming more affordable domestically. A contraction in budgetary policy has the opposite effect, causing the exchange rate to depreciate. In the case of expansion of budgetary policy, export-oriented companies and their employees stand to lose the most.

METHODS OF CREDIT CONTROL

  1. BANK RATE – It is the rate at which central bank lends money to the commercial bank and rediscounts the bills of exchange presented by the commercial bank . The RBI defines the bank rate as the standard rate at which the bank is prepared to buy or rediscounts the other bills of exchange or other commercial papers eligible for purchase under this act . When commercial bank faces shortage of cash reserves , they approach the central bank to borrow money for short term . The central bank rediscounts the bill presented by the commercial bank at a discount rate . The central bank can change this rate depending upon weather it wants to expand or reduce the flow of credit from the commercial bank . When it wants to increase the credit creation capacity of the commercial bank , it reduces the discount rate and when it decides to decrease the credit creation capacity of the bank , it increases the bank rate .
  2. CASH RESERVE RATIO(CRR) – It is also known as Statutory reserve ratio(SRR) , is the percentage of total deposits which commercial bank required to maintain in the form of cash reserve ratio with the central bank . The objective of the cash reserve ratio is to prevent the shortage of cash for meeting the cash demand of the depositer . since the cash reserve are non interest bearing , commercial bank often keep their cash reserves below safe limit . The CRR has proved to be a useful tool for the central bank to control money supply . The central bank enjoys the legal power to change the cash reserve ratio of the banks ..
  3. OPEN MARKET OPERATIONS – It refers to the buying and selling of government securities by the central bank to the public and commercial bank . RBI is authorized to sell or purchase treasury bills and government securities . Sale of securities by central bank reduces the reserves of the commercial banks . It affects the bank ability to create credit and it decreases the money supply . Purchase of the securities by central banks increases the reserves and raises the banks ability to give credit .
  4. MARGINAL REQUIREMENTS – Margin is the difference between the amount of loan and market value of security offered by the borrower against the loan . By changing the margin requirements the reserve bank can alter the amount of loans made against securities by the bank .
  5. MORAL SUASION – This is a combination of persuasion and pressure that central bank applies on the other banks in order to get them in a manner with its policy . It is exercised through discussions, letters and hints to bank.

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