Notes on Contra-Cyclical Budget | Fiscal Policy

In modern days budget is recognized as an efficient fiscal instru­ment in the hands of the Finance Minister for materializing the prime objective of economic growth and development.

However the ortho­dox economists refuse to accept the efficacy of the budget. For them budget was only a financial statement showing the revenue and expenditure of the government.

The great depression of 1930s made a rethinking in the concept of fiscal policy as such. The faith in the virtues of balanced budget was challenged and the Keynesian economists prescribed a special counter cyclical budgeting policy for rectifying the disturbance of boom and depression.

The counter cyclical budgeting rest upon two fundamental policy prescriptions. They are:

(a) Maximisation of expenditure and minimisation of taxation during depression, and

(b) Maximization of taxation and minimization of expenditure during boom. In essence it means adopting a deficit budget during depression and a surplus budget during boom.

Even in the changed circumstances of 1930’s, the orthodox economists and conservative business class rejected the prescrip­tion of counter-cyclical budgeting. They were still under the strong faith of the automatic adjustability of the capitalist system.

They were under the misguided notion that a competitive capitalist economy possesses certain built-in-stabilizers, capable of restoring normally in the economy by way of its automatic functioning. Since the economy is capable of rectifying the fluctuations, by the automatic functioning of these stabilizers they propagated that the government need not interfere in the normal functioning of the economy.

Justifying the orthodox reasoning, prof. Samuelson describes the operation of the built-in-stabilizers thus:

“Just as an aero plane possess automatic pilots that gyroscopically leveled it off, after each gust of wind, even when the human pilots is dozing. So does the modern economic system which possesses automatic built-in stabilizers.”

These mysteri­ous stabilizing agents which were in operation in the economy of USA were four in number:

(a) The progressive tax structure mechanism,

(b) The employ­ment compensation and welfare measures,

(c) Farm -in aid programme, and

(d) Corporate saving and Family saving.

These stabilizing, agent will automatically function in the desired direction to mitigate the evils of boom and depression. Hence it was the ex­pectation of the orthodox section in USA that these built in stabilizers would correct the imbalance in the economy.

The advocates of or­thodox reasoning presumed that the presence of these built-in-stabilizers will save the economy from the evils of boom and depres­sion. But the necked realities of 1930’s gave a rude shock to the belief of the classical economists in the faith of balanced budget.

The depression of 1930’s shockingly proved that the built-in-stabilizers are very feeble and ineffective to fight depression. Hence there aroused a felt need for framing a special contra-cyclical fiscal policy

The pros and Cones of a contra-cyclical budget can be realized only through a comparison of its operation with that of a normal budget.

A normal budget is a balanced one, whereas contra-cycli­cal budget proposed the creation of a surplus budget during inflation and deficit budget during depression.

The operational significance of a balanced budget during periods of economic fluctuations is illustrated in the following diagram:

Diagram I Illustrates the effect of a normal budget on the fluctua­tions caused by business cycle. Diagram II illustrates the impact of contra cyclical budget on economic fluctuations. In diagram I G.K. represent the normal balanced budget, in tune with the requirements of orthodox theory.

GHI represent area of fluctuations caused by boom, resulting from the adoption of a balanced budget UK repre­sent the area of fluctuation caused by depression, resulting from the adoption of balanced budget.

In figure No. 2 GK represents the adoption of a normal balanced budget as per the requirements of orthodox budgeting principles. However in tune with the requirement of contra-cyclical fiscal policy, the budget is deliberately made a surplus one during boom to avoid fluctuations.

GHI indicates the surplus budget. This in turn represents the area saved from the fluctuations caused by depression. Hence it is clear that contra cyclical fiscal policy is capable of mitigating the disturbance caused by business cycle.

The graphical representa­tion clearly shows, that contra cyclical budget to a great extend can minimize the area of fluctuation even though it cannot eliminate the disturbance completely. The investing classes raised serious concerns about the effi­ciency and implication of contra cyclical budgeting which was basi­cally against the orthodox budgeting principles followed for a pretty long time.

Hence economic thinkers influenced by the arguments of investing class suggested that the budgetary changes envisaged under contra-cyclical policy should be implemented through the in­strument of two separate budgets.

That is the normal budget and abnormal budget. Literally the suggestion for two separate budgets cannot be accepted. However the rationale behind the argument should be recognized within the frame work of a contra cyclical bud­get.

A contra cyclical budget should possess two components:

(a) Revenue budget (normal budget), and

(b) Capital budget (abnormal or counter cyclical budget).

The normal budget deals with the ordinary source of revenue like taxes, fees etc. and with the normal items of expenditure administrative, law and order expenses etc. Under this principle this part of the budget is supposed to be balanced.

The component capital budget deals with unusual items of revenue like borrowing and extraordinary items of expenditure like government development expenditures and public works programmes. This part of the budget should be made a surplus during boom and deficit during depression.

The adoption of such a budget will help to assume the investing class and the orthodox school of thought that the normal budget is balanced and that there is nothing wrong with the economy.

It will also help to give a signal to the public that the government has not abandoned its traditional budgeting policy. Moreover the special bud­get is considered to be only a temporary remedy against cyclical fluctuations.

The advocators of counter cyclical budgetary proce­dure suggested the framing of a permanent council consisting of economists, businessmen, engineers to advice the government in its anti-depression expenditure policies.

The council armed with poli­cies and concrete programme will act as a catalyst to help the gov­ernment in the launching of the anti-cyclical finance programmes. The success of counter-cyclical fiscal policy depends on a great extend upon the efficiency of the government machinery in planning and launching the various public workers programme and it’s duly completion without much delays.

As Prof. Halm points out in following an anti-cyclical budgetary policy, we give up old fashioned ideas and consider deficit budgeting during depression as a virtue rather than a sin.