Fiscal policy is a government policy for managing the economy. In these actions, a government changes its tax rates and spending amounts. They do this to influence the national economy in a certain way. Fiscal policy’s sister strategy is called monetary policy. In this complementary series of government actions the central bank adjusts the country’s money supply. They do this to pursue the national economic goals.
Governments adjust their fiscal policy by altering the government spending and tax levels. They do this to impact the amount of economic activity in the country. It is an attempt to change the aggregate demand to boost consumer and business spending. Aggregate demand proves to be the complete amount of spending in the economy. This is the total combination of consumer spending, business spending, and government spending.
There are a number of reasons that a government uses fiscal policy. They are to affect growth and inflation rates. Fiscal policy can effectively boost and encourage economic growth when the economy is suffering in a recession. It can also be used keep inflation under control at a targeted level. This is accomplished by cutting government spending levels. Ultimately the purpose of this type of policy is to stabilize the nation’s economic growth. Governments hope to avoid the common boom and bust cycles in the economy this way.
Many times governments will use this fiscal policy alongside monetary policy. Much of the time governments prefer to utilize monetary policy in their efforts to stabilize the economy. Monetary policy is easier to change. It also makes less of a dramatic and potentially disruptive impact on an economy.
Expansionary fiscal policy is the type a government employs when the economy slows down. This is also known as loose fiscal policy. To engage in it the government must increase the aggregate demand. They will do this by one of three methods. They may increase the government spending to create more demand and jobs. They can cut taxes to put more money in consumer’s and business’ hands. This will increase consumer spending as they effectively receive a greater amount of disposable income. In some cases governments may choose to both boost spending and reduce taxes.
There are side effects of this expansionary policy. The government budget shortfall, or deficit, will worsen. As a result, the government must increase the amount of money it will borrow to finance the spending.
Deflationary fiscal policy is the opposite of expansionary policy. In deflationary policy the government becomes concerned about how fast the economy is growing. They attempt to slow it down. This is also known as tight fiscal policy. For a government to pursue this policy they must reduce the amount of aggregate demand. They will do this in one of three ways. They might reduce the government spending. Governments could also raise taxes. A higher level of taxes forces consumers to reduce their spending. The government might also both cut its spending and raise taxes in conjunction.
While this slows economic growth, it does have a positive side effect. The government budget deficit improves as a result of cutting government spending and raising taxes. The government can choose to reduce borrowing and pay down national debt.
Fiscal policy arose from the economic theory of John Maynard Keynes the British economist. He argued that government is able to affect change on macroeconomic levels of productivity. They could do this by raising or lowering public spending amounts and tax levels. According to Keynes, they are able to reduce inflation, keep the currency value healthy, and boost employment with this tool. These ideas are also called Keynesian economics in honor of his work.