Fiscal policy is the policy under which the government of a country uses fiscal measures (or instruments) to correct excess demand and deficient demand and to achieve other desirable objectives. There are mainly three types of fiscal measures, viz.

a. Taxes

b. Public expenditure

c. Public borrowing


(a) Taxes:

Excess of aggregate demand over aggregates supply is caused due to the excess amount of money income is the hands of the people in relation to the available output in the country. In order to correct such situation personal disposable incase should be reduced. Therefore, government should increase the rate of personal income tax, and corporate income tax so that people will have less money in their hands and aggregates demand will fall.

On the other hand, deficient demand is caused due to low level of personal disposable income. Therefore, government of a country should reduce the rate of direct taxes such as personal income tax, and corporate tax.

(b) Public expenditure:


Public expenditure is an important component of aggregate demand. Therefore, excess demand can be corrected by reducing government expenditure. Reduction in government expenditure also leads to a decline in the volume of national income due to the backward operation of investment multiplier. Reduction in national income leads to a decline in aggregate demand and fall in the price level.

On the other hand, government should increase expenditure on public works programmes such as the construction of roads, expansion of railways, setting up of power projects, construction of irrigation projects, schools and colleges, hospitals and parks and so on. Besides, government should also enhance expenditure on social security measures, like old age pensions, unemployment allowances, sickness benefits etc. As a result, national income would rise due to the operation of multiplier and aggregate demand for goods would expand.

(c) Public borrowing:

Like tax and public expenditure, public borrowing is also an important anti – inflationary instrument. Government of a country should resort to borrowing from the non-bank public to keep less money in their hands for correcting the state of excess demand and inflationary situation. On the other hand, to correct deficient demand, government should reduce borrowing from the general public so that purchasing power in the hands of the people is not reduced. Rather, government should repay the past loans to the people to increase their disposable income.


Besides the above fiscal measures, government should resort to deficit financing to correct deficient demand. Deficit financing is a technique of financing a deficit budget by (i) printing notes, & (ii) borrowing from the central bank or drawing down the cash balances on part of the government from the central bank. In any case, deficit financing makes an addition to the total money supply of the country and can correct deficient demand. However, deficit financing beyond a limit may produced inflationary situation in a country. Therefore, deficit financing must be kept within a limit and should be used with caution and care.

However, fiscal measures alone cannot eliminate the situations of excess demand and deficient demand.