Fiscal policy
Also written Fiscal policies · Expansionary fiscal policy · Contractionary fiscal policy · Neutral fiscal policy
The government's measures on its own revenues and expenses — taxation and spending — used to influence aggregate demand, savings, investment and overall economic activity.
In plain language
A government has 2 big levers. It can change what it takes in through taxes, and it can change what it spends.
Pull either one and the whole economy feels it. Lower taxes leave more money with households and companies to spend. Higher public spending puts money to work directly.
That is fiscal policy. It belongs to the government, and only to the government. The central bank has its own set of levers, and those are called monetary policy.
The workbook sorts fiscal policy into 3 stances, depending on which way the government is leaning.
How it works
The definition. Section 5.3.6: "Fiscal policy contains the measures of the Government which deal with its revenues and expenses." It matters because when government changes its income — "primary source being taxation" — and its expenditure, "it influences aggregate demand, supply, savings, investment, and the overall economic activity in the country." The workbook's own list of what that expenditure covers: education, healthcare, police, military forces, interest on borrowing, administrative machinery and welfare benefits.
The 3 stances. The workbook categorises fiscal policy by what the government is doing:
| Stance | When it is used | What government does | Result |
|---|---|---|---|
| Neutral | Income and expenditure in equilibrium | No major changes needed | — |
| Expansionary | Recessions and a slow-moving economy | Spends more, taxes less, leaving more money with citizens and corporates | Fiscal deficits |
| Contractionary | Inflationary conditions and debt burden that have overheated the economy | Spends less, taxes more, leaving less money with citizens and corporates | Fiscal surplus |
How expenditure is funded. 2 routes. Recurring revenue income from direct and indirect taxation, interest on debt investments and dividend income from equity investments in public sector undertakings. And capital transactions in the form of foreign currency and domestic currency borrowing, and sale of assets — disinvestment in public sector undertakings.
The deficit chain. Budgeted excess of expenditure over revenues in a year is the fiscal deficit, "generally defined as a percentage of GDP." It is bridged through market borrowings, short-term and long-term. Then the consequence: "A large fiscal deficit, and consequently a higher borrowing by the government, will push up interest rates in the economy and make it difficult for corporate borrowers to access funds. A high interest rate environment is detrimental to economic growth."
On figures. The workbook gives no numeric fiscal-deficit target anywhere in chapter 5 — no 3% rule, no statutory ceiling. It says only that the deficit is expressed as a percentage of GDP. Supplying a figure from elsewhere is not answering this paper.
A worked example
Illustrative. A government's budget for one year.
| Line | Amount |
|---|---|
| Revenue receipts (taxes, interest, PSU dividends) | Rs 27,00,000 crore |
| Total expenditure | Rs 34,00,000 crore |
| Fiscal deficit | Rs 7,00,000 crore |
| GDP | Rs 3,20,00,000 crore |
| Deficit as a share of GDP | 2.2% |
That Rs 7,00,000 crore has to be bridged by market borrowing, as the workbook says. So the government becomes the largest borrower in the bond market that year.
Now suppose a slowdown arrives and the government turns expansionary: it cuts income tax rates and adds Rs 3,00,000 crore of road and railway spending. Revenue falls to Rs 25,00,000 crore and expenditure rises to Rs 37,00,000 crore, so the deficit doubles to Rs 12,00,000 crore, or 3.75% of GDP.
Households now have more money, which is the point. But the extra Rs 5,00,000 crore of government borrowing competes with every company trying to issue a bond. A mid-sized manufacturer that would have borrowed at 8.6% now pays 9.3%, and on Rs 2,000 crore of debt that is Rs 14 crore a year of extra interest. This is the workbook's own crowding-out chain running end to end: bigger deficit, more borrowing, higher rates, harder access to funds for corporate borrowers.
Why NISM asks about it
Chapter 5.3.6 (Fiscal Policies and their Impact on Economy) is paired with 5.3.7 on monetary policy, and section 5.4 explains why an equity analyst tracks both.
The chapter's Sample Question 3 comes straight from here: "The fiscal deficit is bridged by the government through market borrowings, both short-term and long term. State whether True or False." The answer is True. Sample Question 1 tests the pairing of policy to policy maker — government and central bank.
Beyond that, expect a stance question: a recession calls for expansionary policy and produces a deficit; overheating calls for contractionary policy and produces a surplus. And expect the crowding-out chain, since 5.4 says the fiscal deficit number tells an analyst whether the government has room left to spend.
Common exam traps
- Fiscal policy is the government; monetary policy is the central bank. Both are described as expansionary or contractionary, which is exactly why they get swapped.
- Expansionary means spend more and tax less, and the workbook says it results in fiscal deficits. Deficit is the consequence, not the policy.
- Contractionary policy is used against inflation and debt burden, not against a recession.
- A large deficit raises interest rates and crowds out corporate borrowers. Learn the chain in that order; a question may enter it at any point.
- There is no deficit target in this workbook. It states only that the deficit is generally expressed as a percentage of GDP.
- Disinvestment in public sector undertakings is a capital transaction, not recurring revenue income. PSU dividends are recurring revenue; selling the PSU is not.
- A high current account deficit is not the same as a high fiscal deficit. Section 5.3.6 discusses both in the same passage and they have different causes and different effects on the currency.
Check yourself
1.Two major influencers of the economic policies in an economy are __________ and __________.
- a)Government; Central Bank
- b)Stock Exchanges; Government
- c)Central Bank; Stock Exchanges
- d)Commercial Banks; Rating Agencies
Show the answer
Answer: (a) Government; Central Bank
The workbook states it directly: "Two major influencers of the public policies in an economy are the government and the central bank." Government decisions, collectively, are fiscal policy; central bank actions, collectively, are monetary policy.
Why the others are wrong: stock exchanges are trading venues, not policy makers — they set trading rules, not economic policy. Commercial banks transmit monetary policy, they do not make it. Rating agencies opine on credit quality and have no policy role at all. This exact question appears in the workbook's own sample set, so answer it in the wording above.
2.Which economist does the workbook cite for the view that governments could change the economic performance of industries by adjusting tax rates and government spending?
- a)Adam Smith
- b)John Maynard Keynes
- c)Milton Friedman
- d)David Ricardo
Show the answer
Answer: (b) John Maynard Keynes
British Economist John Maynard Keynes (1883–1946) believed that governments could change economic performance of its industries by adjusting tax rates and government spending.
The workbook cites him to justify why economic analysis belongs in a research analyst's work at all: therefore, as growth depends largely on the economic environment, it becomes important for analysts to understand the economy.
The focus areas that follow: changes in various macro-economic factors like national income, inflation, interest rate and unemployment rate · fiscal and monetary policies and their impact on the economy · flows from Foreign Direct Investment (FDI) and Foreign Portfolio Investors (FPIs) · savings and investment patterns · global factors that impact the GDP growth based on export and import transactions.
Those five items are the skeleton of Chapter 5, Economic Analysis, which carries 5% of the paper — so learning them here pays twice.
The two levers Keynes named — tax rates and government spending — are together what the syllabus later calls fiscal policy, as distinct from the monetary policy run by the central bank.
3.Which statement about the primary trend is consistent with the workbook?
- a)It is the dominant long-term movement, typically lasting one year or more, and is largely driven by macro-level forces such as economic cycles and monetary and fiscal policy
- b)It typically lasts three weeks to three months and is driven mainly by earnings surprises and sector-specific news
- c)It is best identified with 5-day, 10-day and 20-day EMAs
- d)It can only be a bull or a bear market; a range-bound market does not count as a primary trend
Show the answer
Answer: (a) It is the dominant long-term movement, typically lasting one year or more, and is largely driven by macro-level forces such as economic cycles and monetary and fiscal policy
The primary trend is "the dominant, long-term movement in the price of a financial asset or market index … over an extended period of time, typically one year or more." Its underlying drivers are "macro-level forces such as: economic cycles (growth vs recession), monetary policy (interest rates, liquidity), fiscal policy (taxation, government spending), geopolitical stability, investor psychology".
Option B is the secondary trend on both counts — it lasts "3 weeks to 3 months and sometimes more", and "earnings surprises or sector-specific news" are listed among its catalysts. Option C lists the tools for the tertiary trend ("5-day, 10-day, or 20-day EMAs for trend confirmation"); for primary trends the workbook names moving averages "like 50 or 100 DMA". Option D ignores the third category in the workbook’s table: sideways or rangebound, where prices fluctuate within a horizontal range and sentiment is "neutral or uncertain".
Where this is taught
Free preparation for NISM Series XVRelated terms
- Fiscal deficitThe budgeted excess of the government's expenditure over its revenues in a year, usually stated as a percentage of GDP and bridged by borrowing.
- InflationA sustained general rise in the price level, which erodes what a rupee buys — and the reason a nominal return has to be deflated before it means anything.
- MacroeconomicsThe study of the economy as a whole — the aggregate supply and demand factors such as GDP, unemployment, inflation, savings and investment, and the public policies that move them.
- Monetary policyThe central bank's management of money supply and interest rates to promote growth and hold prices stable — expansionary when it wants to push the economy up, contractionary when it wants to cool it.
- National savingThe savings of an entire economy, arrived at by adding the savings of its three constituents — personal savings, corporate savings and public savings.
- Repo rateThe rate at which the central bank lends money to banks for a very short term against approved securities — the main lever it pulls to make money cheaper or dearer.
- Leading economic indicatorA measure of economic recovery that improves before the actual economy does, because it reflects expectations for the future rather than current or past activity — and the workbook names the stock market itself as one.
- FDIForeign capital that comes into a country in active form, where the investing entity participates in decision making and drives the business, as opposed to passive portfolio investment.