What Is Counter- Cyclical Fiscal Policy?

 

 

The Economic Survey

The latest economic survey expects a V-shaped recovery of Indian economy with the GDP estimated to grow at 11% for 2021-22. One of the vital themes of the survey was a push in public spending in the budget. 

It says that while fiscal policy is especially salient during an economic crisis, in general, fiscal policy must be counter-cyclical to smooth out economic cycles instead of exacerbating them. 

Hence, the govt. should not worry about debt or be fiscally conservative at a time of global slowdown. Before analyzing how this policy can help the economy grow, we must understand the difference between a pro cyclical and counter-cyclical fiscal policy. 

Pro-Cyclical Fiscal Policy

In a pro-cyclical fiscal policy, the govt. reinforces the business cycle by being expansionary during good times and contracting during recessions, thus moving in the same directions as of business cycles.

However, it could raise macroeconomic volatility, depress investment in real and human capital, hamper growth and especially harm the poor. On the other hand, a counter-cyclical fiscal policy involves the govt. taking steps against the direction of economic or business cycle. 

This means that in a recession or slowdown, govt. should increase expenditure and reduce taxes to create a demand that can drive an economic boom. Vis-a-vis, during a boom in the economy, policy should aim at raising taxes and cutting public expenditure to control inflation and debt. 

So, as the economy is facing huge contractions in terms of growth and employment due to COVID-19, it is advised that govt. should focus on huge expenditure for the economy to revive. 

Currently in India, when private consumption, which contributes to 54% of GDP, is contracting and investment, which contributes to around 29%, is uncertain, the relevance of counter-cyclical fiscal policy is paramount. 

Conclusion

But the question is how does such kind of policy actually works? Well, multiple channels are involved in this process. Firstly, an expansion in government expenditure cushions the contraction in output by offsetting the decline in consumption and investment. 

Then, higher govt. spending builds confidence in tough times as through this policy, governments are able to show their commitment to sound fiscal management.

This in turn gives confidence to the private sector that the economy will not fluctuate too much. It helps businessmen overcome risk aversion and brings animal spirits in the economy.

Written By - Nidhi Verma