Fiscal policy is the budgetary policy of the government relating to taxes, public expenditure, public borrowing and deficit financing. The major anti-inflationary fiscal measures include (a) increase in taxation, (b) reduction in public expenditure, (c) increase in public borrowing, and (d) control of deficit financing.
1. Increase in Taxation:
Anti-inflationary tax policy should be directed towards restricting demand without restricting production.
Excise duties and sales tax on various goods, for example, take away the buying power from the consumer goods market without discouraging the expanding productive capacity of the economy.
Some economists, therefore, prefer progressive direct taxes because such taxes on the one hand, reduce the disposable income of the people and, on the other hand, are justified on the basis of social equity.
2. Reduction in Public Expenditure:
During inflation, effective demand is very high due to expansion of public and private spending. In order to check unregulated private spending, the government should first of all reduce its unproductive expenditure.
In fact, during inflation, at the full employment level, the effective demand in relation to the available supply of goods and services is reduced to extend that government expenditure is curtailed.
Public expenditure being autonomous, an initial reduction in it will lead to a multiple reduction in the total expenditure of the economy. But, there are certain limitations of this measure:
(a) It is not possible to reduce public expenditure related to defence needs particularly during war times.
(b) Heavy reduction in government expenditure may come into clash with the planned long-run investment programmes in a developing economy.
3. Public Borrowing:
Public borrowing is another method of controlling inflation. Through public borrowing, the government takes away from public excess purchasing power. This will reduce aggregate demand and hence the price level.
Ordinarily public borrowing is voluntary, left to the free will of individuals. But voluntary public borrowing may not bring to the government sufficient funds to effectively control the inflationary pressures.
In such conditions, compulsory public borrowing is necessary. Through compulsory public borrowing a certain percentage of wages or salaries is deducted in exchange for saving bonds which become redeemable after a few years.
In this way, purchasing power can be curtailed for a definite period to curb inflation. Compulsory public borrowing has certain limitations,
(a) It involves the element of compulsion on the public,
(b) It results in frustration if the government borrows from the poorer sections of the public, who cannot contribute to this scheme,
(c) The government should avoid paying back die past loans during inflationary period, otherwise it will generate further inflation.
4. Control of Deficit Financing:
Deficit financing means financing the deficit budget (i.e. excess of government expenditure over its revenue) through printing of new currency. In order to control inflation, the government should minimise deficit financing.
The important thing is that, as far as possible, the deficit should be financed through saving or taxation. The government can sell bonds to non-bank investors, like insurance companies, saving banks etc., which will take away the spending power from the public and thus curb inflation.