Fiscal Policy

Fiscal policy refers to the use of government spending and tax policies to
affect economic conditions, especially macroeconomic conditions, including

aggregate demand for goods and services, employment, inflation, and
economic growth. Fiscal policy is largely based on the opinions of British
economist John Maynard Keynes (1883-1946), who disputed that
economic recessions are due to a deficiency in the consumption spending
and business investment components of aggregate demand. Keynes
believed that governments could stabilize the business cycle and regulate
economic output by regulating 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 included massive spending on
public works projects and social welfare programs. In Keynesian
economics, aggregate demand or spending is what drives the performance
and increase of the economy. Aggregate demand is consist of consumer
spending, business investment spending, net government spending, and
net exports. According to Keynesian economists, the private sector
components of aggregate demand are too different 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, and
excessive abundance during good times can lead to an overheated
economy and inflation. However, according to Keynesians, government
taxation and spending can be regulated rationally and used to counteract
the excesses and deficiencies of private sector consumption and
investment spending in order to stabilize the economy. When private sector
spending turns down, the government can waste more and/or tax less in
order to directly increase aggregate demand. When the private sector is
over optimistic and spends too much, too fast on consumption and new
investment projects, the government can waste less and/or tax more in
order to decrease aggregate demand. This means that to help stabilize the
economy, the government should run big budget deficits during economic
downturns and run budget surpluses when the economy is growing.Main
advantages of fiscal policy are 1-Can Direct Spending To Specific
Purposes Unlike monetary policy tools, which are general in nature, a
government can regulate spending toward specific projects, sectors or
regions to stimulate the economy where it is perceived to be needed to
most.2-Can Use Taxation to Discourage Negative Externalities
Taxing polluters or those that overuse limited resources can help vanish
the negative effects they cause while generating government revenue.3-
Short Time Lag
The effects of fiscal policy tools can be seen much faster than the effects of
monetary tools. Also we can say that for economy monetary and fiscal
policy must complement each other. For instance, to a Keynesian
promoting fiscal policy over a long period of time (e.g. 25 years), the
economy will go through many economic cycles. At the end of those cycles,
the hard assets, like infrastructure, and other long-life assets, will still be
standing and were most likely the result of some type of fiscal interference.
Over that same 25 years, the Fed may have intervened hundreds of times
using the monetary policy tools and maybe only had success in their
purposes some of the time. Using just one policy may not be the best idea.
There is a lag in fiscal policy as it filters into the economy, and monetary
policy has shown its effectiveness in slowing down an economy that is
heating up at a faster-than-desired pace, but it has not had the same effect
when it comes to rapid-charging an economy to expand as money is
eased, so its success is muted..
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Fiscal Policy

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Fiscal policy refers to the use of government spending and tax policies to

affect economic conditions, especially macroeconomic conditions, including

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