Fiscal policy

Fiscal policy is a government practice that refers to adjusting tax rates, or revenue, and spending levels, or expenditures, in an attempt at influencing a nation’s economic system. Fiscal policy is closely related to the practice of monetary policy, which is a system used by a national, or central, bank to stimulate a country’s monetary supply. Depending upon the specific circumstances, fiscal and monetary policies can be used by a government system in combination in an attempt to improve existing economic conditions. Fiscal policy itself is a practice used by both economists and political scientists and helps direct policies made at the national level. There are a number of overarching goals in fiscal policy decisions, including improvement in the allocation of specific resources within the government and private sectors, increasing the level of economic activity, and increasing the distribution of income.

Background

In the United States, the practice of fiscal policy is rooted in the Great Depression. Prior to the stock market crash of 1929, the US federal government had less of a role in the nation’s economy and its assorted circulatory patterns. But when the lingering effects of the Great Depression passed after World War II, several economists convinced federal lawmakers to have more involvement in the economy. This was accomplished in part by enacting policies that regulated levels of inflation and deflation, the rate of unemployment, business cycles, and the true cost of money itself. The theory behind fiscal policy states the government has the ability to control certain degrees of economic activity through the policies and philosophies of lawmakers.

From the 1950s onward, the US federal government began using taxation and government spending as a mechanism toward stimulating economic activity—particularly during certain downward spirals in the nation’s economy. This diverges from the related practice of monetary policy, which has been used to address the nation’s supply of actual money through the imposition of interest rates and lending rates. In the instance of monetary policy, the US central bank system is frequently enlisted to administer specific interest and lending rates.

While the practices of fiscal policy have been used prevalently in the United States, the principles of the practice itself are credited to British economist John Maynard Keynes. Through his own theories, Keynes asserted the central government can influence levels of productivity—at least on a macroeconomic scale—by changing the levels of taxation and public spending. In his theory, Keynes said taxation and spending could be increased or decreased, depending upon the specific economic situation facing a country. In a downward pattern, the practices could be used to increase employment. On the other end of the spectrum, implementation of fiscal policy can mitigate unwieldy levels of inflation in times of economic prosperity.

The practice of fiscal policy was implemented in the aftermath of the housing bubble and economic downturn that began in 2007. After gaining upward momentum, economists feared another recession would loom in January 2013 if the federal government failed to cut government spending and increase tax rates. The end result was the American Taxpayer Relief Act of 2012, which included the principles outlined in Keynes’s theories, and a recession was prevented from occurring.

Overview

Fiscal policy involves three subsets of individual patterns that have been used by economists and lawmakers, depending upon the state of the American economy. As its name suggests, neutral fiscal policy is traditionally used when the nation’s policy is in a state of equilibrium. In this practice, the federal government’s spending is funded fully by tax revenue. As a result, the outcome of the federal budget is equal to the level of economic activity. Another method, contractionary fiscal policy, has been used when the rate of government spending comes in lower than the amount of tax revenue brought in. Contractionary fiscal policy has historically been used to pay down the amount of debt the federal government owes. The third method, expansionary fiscal policy, takes place when government spending exceeds the amount of revenue brought in from taxes. Expansionary fiscal policy is used traditionally during a period of recession.

Over time, lawmakers have used the principles of fiscal policy to influence a number of economic factors, including the overall level of aggregate demand that is used to gauge levels of employment, economic growth, and overall price indexes. In his theory, Keynes asserts that an increase in government spending and a correlating decrease in tax rates is one of the most effective ways of creating an aggregate demand on the forces that are paramount to a nation’s economy. Keynes and other like-minded economists argue a decrease in spending and an increase in taxation should be implemented once an economic surge takes place within a country. In history, this pattern of thinking can be traced to some of the policies within the New Deal, President Franklin D. Roosevelt’s series of domestic programs that contained the “three R’s”—relief, recovery, and reform—to address the many complicated factors that contributed to the Great Depression.

Keynes’s principles have not been without criticism. One particularly pointed critique against the concepts of fiscal policy is the varied affects it can have on individuals and segments of society. For example, a decision to cut taxes to stimulate the economy might only be applied to people within a certain income bracket—for example, members of society falling within the middle class. The same can be said of policymakers’ decisions to implement similar policies that essentially benefit the wealthy. When it comes to enacting employment-related decisions, fiscal policy traditionally benefits workers in less specialized industries, such as construction, whereas professionals in more specialized fields, such aerospace, might not reap the true benefits of lawmakers’ decisions to stimulate the economy. As is the case with any policy decisions, lawmakers are charged with deciding how involved they want to be in drafting policies that influence the economy and which fiscal policies are likely to be most effective in improving their constituents’ lives.

Bibliography

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