What Is Fiscal Policy?

Fiscal policy refers to the use of government spending and tax policies to influence economic conditions, especially 澳洲幸运5官方开奖结果体彩网:macroeconomic conditions. These include aggregate demand for goods and services, employment, inflation,𓆏 and econo🌠mic growth.

During a recession, the government may lower tax rates or increase spending to encourage demand and spur economic activity. Conversely, to combat 澳洲幸运5官方开奖结果体彩网:inflation, i🅷t may raise rates or cut spending to cool down the economy.🗹

Fiscal policy is often contrasted with 澳洲幸运5官方开奖结果体彩网:monetary policy, which is enacted by central bankers and not elected government official💫s.

Understanding Fiscal Policy

U.S. fiscal policy is largely based on the ideas of British economist 澳洲幸运5官方开奖结果体彩网:John Maynard Keynes (1883-1946). He argue🔯d that economic recessions aౠre due to a deficiency in the consumer spending and business investment components of aggregate demand.

Keynes believed that governments could stabilize the 澳洲幸运5官方开奖结果体彩网:business cycle and regulate economic output by adjusting spending and tax policies to make up for the shortfalls of the private sector.

His theories were developed in response to the Great Depression, which defied classical economics' assumptions that economic swings were self-correcting. Keynes' ideas were highly influential and led to the New Deal in the U.S., which involved massive spending on public works projects and social welfare program𒅌s.

In 澳洲幸运5官方开奖结果体彩网:Keynesian economics, aggregate demand or spending is what drives the performance and growth of the economy. 澳洲幸运5官方开奖结果体彩网:Aggregate demand is made u💎p of consumer ꩵspending, business investment spending, net government spending, and net exports.

Variable Private Sector Behavior

According to Keynesian economists, the private sector components of aggregate demand are too variable and too dependent on psychological and emotional factors to maintain sustained growth in the economy.

Pessimism, fear, and uncertainty among consumers and businesses can lead to economic recessions and depressions. What's more, excessive public sector exuberance during good times can lead to an overheated economy and inflation.

However, Keynesians believe that government taxation and spending can be managed rationally and used to counteract the excesses and deficiencies of private sector consumption and investment spending in order to stabilize the economy.

Corrective Government Fiscal Action

When private sector spending decreases, the government can spend more or tax less in order to directly increase aggregate demand. When the pri𝔉vate sector is overly optimistic and spends too much, too quickly on consumption and new investment projects, the government can spend less or tax more in order to decrease aggregate demand. 

This means that to help stabilize the economy, the government should run large budget deficits during economic downturns and run budget surpluses when the economy is growing. These are known as 澳洲幸运5官方开奖结果体彩网:expansionary or 澳洲幸运5官方开奖结果体彩网:contractionary fiscal policies, respectively.  

Types of Fiscal Policies

Expansionary Policy and Tools

To illustrate how the government can use fiscal policy to affect the economy, consider an economy that's experiencing a 澳洲幸运5官方开奖结果体彩网:recession. The government might issue tax stimulus rebates to increase 澳洲幸运5官方开奖结果体彩网:aggregate demand and fuel economic growth. 

The logic behind this approach is that when people pay lower taxes, they have more money to spend or invest, which fuels higher demand. That demand leads firms to hire more, decreasing澳洲幸运5官方开奖结果体彩网: unemployment, and causing fierce competition for labor. In turn, this serves to raise wages and provide consumers with more income to spend and invest. It's a virtuous cycle or 澳洲幸运5官方开奖结果体彩网:positive feedback loop. 

Alternately, rather than lowering taxes, the government may seek economic expansion by increasing spending (withou༺t corresponding tax increases). Building more highways, for example, co꧅uld increase employment, pushing up demand and growth.

Expansionary fiscal policy is usually characterized by 澳洲幸运5官方开奖结果体彩网:deficit spending. Deficit spending occurs when government expenditures exceed receipts from taxes and other sources. In practice, def♒icit spending tends to result from a combination of tax cuts and higher spending.

Contractionary Policy and Tools

In the face of mounting inflation and othe🤡r expansionary symptoms, a government can pursue contractionary fiscal policy, perhaps eveꦜn to the extent of inducing a brief recession in order to restore balance to the economic cycle.

The government does this by increasing taxes, reducing public spe🐎nding, and cutting public sector pa𓃲y or jobs.

Where expansionary fiscal policy involves spending deficits, cont൩ractionary fiscal policy is characterized by budget surpluses. This polಞicy is rarely used, however, as it is hugely unpopular politically.

Public policymakers thus face differing incentives relating to whether to engage in expansionary or contractionary fiscal policy. Therefore, the preferred tool for reining in unsustainable growth is usually a contractionary monetary policy. Monetary policy involves the 澳洲幸运5官方开奖结果体彩网:Federal Reserve raising interest✃ rates and restraining the supply of money and credi🃏t in order to rein in inflation.

Downside of Expansionary Policy

Mounting deficits are among the complaints lodged against expansionary fiscal policy. Critics complain that a flood of government red ink can weigh on growth and eventually create the need for damaging austerity.

Many economists simply dispute the effectiveness of expansionary fiscal policies. They argue that government spending too easily 澳洲幸运5官方开奖结果体彩网:crowds out investment by the private sector.

Expansionary policy is also popular—to a dangerous degree, say some economist♔s. Fiscal stimulus is politically difficult to reverse. Whether it has the desired macroeconomic effects or not, voters like low taxes and public spending.

Due to the political incentives faced by policymakers, there ten🧜ds to be a consistent bias toward engaging in more-or-less constant deficit spending that can be in part rationalized as good for the economy. 

Eventually, economic expansion can get out of hand. Rising wages lead to inflation and 澳洲幸运5官方开奖结果体彩网:asset bubbles begin to form. High inflation and the 澳洲幸运5官方开奖结果体彩网:risk of widespread defaults when debt bubbles burst can badly damage the economy. This risk, in turn, leads governments (or their central banks) to reverse course and attempt to contract the economy.

Fiscal Policy vs. Monetary Policy

Fiscal policy is the responsibility of the government. It involv🐻es spurring or slowing economic activity us♒ing taxes and government spending.

Monetary policy, on the other hand, is the domain of the U.S. 澳洲幸运5官方开奖结果体彩网:Federal Reserve Board and refers to actions taken to increase or decrease 澳洲幸运5官方开奖结果体彩网:liquidity through the nation's money supply. According to the Federal Reserve Board, these actions are intended to "promote maximum employment, stable prices, and moderate long-term interest rates—the economic goals the Congress has instructed the Federal Reserve to pursue."

The monetary policy tools that the Fed uses to increase or decrease liquidity (and affect consumer spending and borrowing) include:

• Buying or selling securities on the open market
• Lending to depository institutions through its 澳洲幸运5官方开奖结果体彩网:discount window
• Raising or lowering the 澳洲幸运5官方开奖结果体彩网:discount rate
• Raising or lowering the 澳洲幸运5官方开奖结果体彩网:federal funds rate
• Establishing reserve requirements for banks
• Engaging in central bank liquidity swaps
• Financing through 澳洲幸运5官方开奖结果体彩网:overnight repurchase agreements

The Bottom Line

Fiscal policy is directed by the U.S. gov𓄧ernment with the goal of maintaining a healthy economy. The tools used to promote beneficial economic activity are adjustments to tax rates and government spending.

When economic activity slows or deteriorates, the government maﷺy try to improve it by reducing t🎶axes or increasing its spending on various government programs.

When the economy is overly active andಌ inflation threatens, it may increase taxes or reduce spending. However, neither is palatable to politicians seeking♔ to stay in office. Thus, at such times, the government looks to the Fed to take monetary policy action to reduce inflation.