The budget has two components. These are revenue or current account and capital or debt account. The revenue account displays receipts from tax collection and from other sources of public income during the course of the year. The capital account shows all debt liabilities and payments of interest on loans. Government loans may be internal in the form of borrowing from the people, banks or the central bank. It may also be in the form of external debt from international agencies like the International Monetary Fund (IMF) or International Bank for Reconstruction and Development (IBRD).
b) Budgetary Surplus or Deficit: If the current or revenue account receipts are exactly equal to proposed expenditure, then the budget is said to balanced. If the revenue receipts fall short of the proposed expenditure then it is a case of a deficit budget. On the other hand if revenue receipts exceed the proposed expenditure then it is called Surplus budget. In order to avoid public intervention in economic activities the classical economists used to favor balanced budgets i.e. when the government expenditure is exactly equal to the tax revenues.
In case of a deficit budget, the government expenditure has exceeded receipts. Therefore, the government intends to spend more and increase the size of the aggregate or effective demand. This can be done by raising fresh debts to finance extra expenditure. Alternatively, the tax rates can also be reduced in order to enable people to spend more.
The case of surplus budget is exactly the opposite. Here, public revenue exceeds public expenditure. It then becomes possible for the government to repay some debt burden. It is also possible to raise tax rates and to withdraw some purchasing power from circulation.
c) Expansionary and Contractionary policies: Fiscal policy becomes meaningful when budgets either show deficits or surpluses. The deficit budget is also known as an expansionary policy. This is because through deficits and enhanced public spending, the overall level of effective demand can be expanded. Such a policy is pursued during the period of deflation. Under such conditions the price level is depressed, the output level is falling and the level of unemployment is increasing. Therefore the rising level of effective demand is expected to act as a remedy.
On the other hand a surplus budget (which is also known as contractionary) policy is useful under inflationary conditions. During inflation, the general price level shows a strong tendency to move sharply upwards. Therefore such a situation can be corrected by withdrawing some purchasing power from the people. This helps to bring down the level of effective demand.
As is mentioned above, classical economists generally favored a balanced budget. It is only Keynes and his followers who have popularized expansionary and contractionary policies. However, here again the Keynesians emphasize expansionary policies. It is only in exceptional situations of running away conditions of inflation that the contractionary policy may be called in. Both expansionary and contractionary policies can be illustrated.