Role of Fiscal Policy in Depression:
The role of fiscal policy in a developed economy is to function as an anti-cyclical measure. It assumes a balanced position only in a normal price stability period. During recession or depression, however, the government must adopt a deficit budget policy, while a surplus budget policy is to be followed to combat inflation.
During a depression, a deficit budget can be created in the following ways:
(i) The level of public expenditure is kept unchanged but the taxation rates are reduced.
(ii) Taxation rates are kept unchanged but public expenditure is increased.
The second method is regarded as more significant as an anti-depressionary measure. This excess of expenditure may be financed through public borrowings plus deficit financing, i.e., creation of new money.
Keynes contends that increase in public expenditure or investment in public works will lift the economy out of a depression. The merit of public works programmes is that they increase personal incomes and consumption by a multiple of the initial expenditure without adversely affecting the marginal efficiency of investment in the private sector.
In other words, an increase in government spending will increase national income. Though the idea of public works programmes as a remedy for unemployment is very old, Keynes’ multiplier aspect of it is a modern innovation.
