Page 63 - ES 2020-21_Volume-1-2 [28-01-21]

46 Economic Survey 2020-21 Volume 1

Fiscal policy Recession (↓ GDP) Expansion (↑ GDP) Outcome
(FP) stance
Pro-cyclical Contractionary FP Expansionary FP Deepens recessions and
↓ Govt. Expenditure ↑ Govt. Expenditure amplifies expansions, thereby
or /and or/and increasing fluctuations in the
↑ Taxes ↓ Taxes business cycle.
Counter-cyclical Expansionary FP Contractionary FP Softens the recession and
↑ Govt. Expenditure ↓ Govt. Expenditure moderates the expansions,
or/and or /and thereby decreasing fluctuations
↓ Taxes ↑ Taxes in the business cycle.

Figure A: Business Cycle under Various Fiscal Policy Stance

Channels of Transmission
Recalling the National Income identity , Y= C+I+G+X-M , the net effect of a recession on
the private sector may be in terms of lower private consumption (C), lower private investment
(I), risk aversion by the private sector and pessimistic expectations/sentiments. In such a scenario,
adopting a counter cyclical policy by expanding the Government Expenditure – both consumption
and investment - will support the GDP and minimise the output gap (as seen in the figure above).
This happens primarily through the following channels:

(i) An expansion in Government expenditure can cushion the contraction in output by
contributing to the GDP growth, by offsetting the decline in consumption and investment;
and also by boosting private investment and consumption through higher spending
multipliers during recession. (Auerbach and Gorodnichenko (2012), Riera-Crichton,
Vegh and Vuletin (2014), Jorda and Taylor (2016), Canzoneri et al (2012)).
(ii) Through risk multiplier by compensating for greater risk-aversion of private sector to bring
back ‘animal spirits’.