FAQs on how government influences economy & financial market

1.  What are the main forms of government? Elaborate their functions. 
   The government could be a central, state, or local government (including a municipal body). While the central government is involved in the defence of the country, maintaining law & order as well as framing economic policy, the state government is mainly involved in the local level industrial and economic policy apart from a collection of state-level taxes. The local municipal bodies are involved in local municipal level taxes apart from providing common facilities for the public. 

2. What are the key functions of the Government of India?  
   In addition to defending the nation from external threats via its armed forces, it is also responsible for the maintenance of law & order via the Home Ministry. Other important functions include the Finance Ministry, which regulates taxes & manages the expenditure across various arms of the government as well as the External Affairs Ministry that manages the country’s diplomatic efforts across the world.  

3. What is the Union Budget and how does Finance Ministry use it to influence the economy?  
   The Union Budget is an annual statement of the central government’s financial position. It includes the estimated annual revenue and expenditure of the government apart from taxation changes, which could help or hurt various sectors of the economy. The budget sets out the short, medium, and long-term financial position of the government. In the 2021 Union Budget, the government projected its fiscal deficit (excess of total expenditure over total revenue) at 6.8 per cent of GDP for FY21-22 apart from an estimated fiscal deficit of 9.5 per cent of GDP for FY20-21. 

4. How does the government stimulate the economy? Define high fiscal deficit.  

The government stimulates the economy by engaging in a ‘counter cyclical’ policy. A countercyclical policy means that the government will increase its support for the economy during difficult times by running large fiscal deficits during economic difficulties (i.e. high expenditure vis-a-vis revenue) and increasing taxes when the economy is booming. During an economic downturn, a high fiscal deficit is justifiable, given the weak tax revenues that the government may be receiving. While the government will be issuing additional debt to bridge this fiscal deficit, as the demand for loans will be low in the economy, this larger borrowing will not ‘crowd out’ private investment in the economy. However, higher fiscal deficits may be detrimental for the economy when the economy is doing well as a higher private investment will cause the borrowing rates for the companies to increase. 

5. What are the other measures with which the government influences the economy?   

Some of the other measures that the government may use to influence the economy include the disinvestment programme, which improves the availability of good quality companies in the capital markets apart from helping the government meet its fiscal deficit requirements and the recent move to boost production in the country via the introduction of production-linked incentives (PLIs), helped in building a vibrant manufacturing sector in the economy.