Fiscal and monetary policies are the two major tools available to policy makers to alter total demand, output, and employment. This feature will focus on fiscal policy, what it is and its potential and limitations as a tool with which to promote economic stability and strong growth.
What is Fiscal Policy?
When the supply of money is economic constant, government expenditures must be financed by either taxes or borrowing. Fiscal policy involves the use of the government’s spending, taxing and borrowing policies. The government’s budget deficit is used to evaluate the direction of fiscal policy.
When the government increases its spending and/or reduces taxes, this will shift the government budget toward a deficit. If the government runs a deficit, it will have to borrow funds to cover the excess of its spending relative to revenue. Larger budget deficits and increased borrowing are indicative of expansionary fiscal policy. In contrast, if the government reduces its spending and/or increases taxes, this would shift the budget toward a surplus. The budget surplus would reduce the government’s outstanding debt. Shifts toward budget surpluses and less borrowing are indicative of restrictive fiscal policy.
It is important to note that a budget deficit is different from the national debt. A deficit occurs when government spending exceeds revenue over a year, quarter or month. A deficit will increase the size of the national debt. Put another way, the deficit adds to the outstanding stock of IOUs issued by the U.S. Government and not yet repaid. Conversely, a budget surplus will reduce the size of the national debt. A surplus permits the government to pay off some of the holders of the federal government’s IOUs. These holders are the bondholders of U.S. Treasuries Bonds, Notes and Bills.
Keynesian View of Fiscal Policy
The English economist, John Maynard Keynes (pronounced “canes”) popularized the use