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Economic Survey 2017 Series-3: Cyclical Policy- India and Advanced Economies

Global crisis, financial management and India

Cyclical policy

It refers to the government’s approach towards spending and taxation during different cyclical economy

Pro cyclical policy

It refers to the government policy of

  • Increasing spending and reducing taxes during boom period
  • Reducing spending and increasing taxes during recession.

So we can say that pro-cyclical policy tends to increase expansion and tends to decrease/limit recession. E.g. GDP and stock prices in Stock exchanges are pro-cyclical, as they tend to increase when economy expands.

Counter cyclical policy

It refers to the opposite approach in fiscal management of

  • Reducing spending and raising taxes during boom period
  • Increasing spending and cutting taxes during recession.

It in opposite to pro- cyclical policy .e.g.  Unemployment tends to decrease with the economic expansion

Progressive taxation policy is an example automatic counter cyclical fiscal policy. It was 1st advocated by Keynes. So a progressive taxation policy tends to decrease demand when the economy is booming by taxing a large proportion of income when economy expands.

BACKGROUND

Since 2008-2009 Global Financial Crisis

  1. Monetary policy ventured into the realms of Near Zero Interest Rates and Quantitative Easing.
  2. Fiscal policy makers aggressively adopted Counter Cyclic measures in the form of increased spending and cutting taxes during recessing period.

But now with the economic recovery policy reversal is required like:

  1. Counter cyclic policy of boom period i.e. reducing spending and raising taxes are being adopted by developed countries.
  2. But these fiscal measures will give better results only when monetary policy makers keep interest rate near zero level.
  3. Zero interest rate coupled with demand rise will increase government’s revenue in the form of increased tax collection.
  4. Reduced government spending and increased revenue will lead the economy to sustainable debt level, leading to fiscal consolidation.

So consequences of these measures are

  1. Fiscal consolidation.
  2. Low unemployment level.
  3. GDP growth.
  4. Rising wages.
  5. Inflation

INDIAN CONTEXT

Measures taken by Advanced Countries (as listed above) were compelled by two economic realities; viz.

  1. Weak economic activities of Advanced Economies (AE).
  2. Monetary policy of AE failed to address the prevailing problems.

But Indian condition is quite different like:

  1. Indian growth rates are substantially high.
  2. Inflation rates are also relatively high.

So,

  1. Monetary policy can’t be brought down to near zero level.
  2. The era of fiscal activism is restricted, as it will accelerate inflation.

Therefore, Indian condition is quite different, any attempt to increase demand and hence economic growth, may trigger higher rate of inflation, leading to difficult Twin Balance Sheet Problem.

In the past 1990-1991 and 2012-2013, we faced similar problems that led to large fiscal deficit and balance of payment crisis.1990-1991 BOP crisis resulted with high Fiscal Deficit while near BOP crisis of 2012-2013 resulted with relatively high but declining Fiscal Deficit.

At present,

  1. We are following pro cyclic policy of boom i.e. increasing government’s spending and decreasing taxes. But ,
  2. At the same time we are having relatively high bank rates to contain inflation. Inflation has been indexed at 4±2% by RBI. So our GDP and Stock Exchange are rising under such diverse conditions as opposed to the Advanced Economies.

 

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