Fiscal Policy

Fiscal policy is the term used to describe the expenses of the government and the method of financing those expenditures through the collection of revenues. There are two ways that a government can finance its obligations: loans and taxation. There are many forms of taxation that a government can employ. Among them are personal income tax, corporate tax, customs and duties levied on imports, value-added tax, estate tax and collection of royalties.

The fiscal policy of a government has a direct influence on that country's economy. The government is involved in fiscal policy any time that it makes payments, purchases goods and services, or even collects taxes. Any change in the government's fiscal policy affects the economy as well as individuals. If there is a tax increase, people have less disposable income and if there is a tax cut, people have more disposable income. The term fiscal policy is mainly connected to the effect those policies will have on the overall economy.

There two terms used to describe fiscal policy are tight fiscal policy and loose fiscal policy. The former refers to a situation in which revenue, or income, is higher than spending; in other words there is a surplus in the budget. Such a policy is sometimes called contractionary. A loose fiscal policy is when spending is higher than revenues; in other words, there is a budgetary deficit. Such a policy is sometimes called expansionary.

The emphasis is often placed not on the level of the deficit, but on the change that has occurred. If the deficit is reduced from $150 billion to $100 billion, the fiscal policy is called contractionary, although a deficit still exists.

There are different types of government expenditures: money that the government spends on goods and services, and money that the treasury provides to other government agencies. All of the monies spent by the government have the effect of stimulating the overall economy. When the economy is contracting, the government can begin spending money and ordering goods and services, thereby boosting the economy and raising consumer confidence. This school of thought is called Keynesian economics, named after the famous economist John Keynes. Keynes believed that the government should play an important and active role in kick-starting the economy during a recession and cutting spending when the economy is growing and thriving.

Should a government need funds in order to provide goods and services to the people, but find that the money is inaccessible, it can always resort to borrowing from the capital markets or the public at large. The government will issue treasury bills, securities and treasury bonds to citizens. These fiduciary notes oblige the government to pay back the amount borrowed at the date of maturity, along with any interest that has accrued.

Borrowing has several effects. It can fuel higher interest rates, forcing the government to pay staggering amounts of money to service its debt. Those sums could have been used to support social service programs. When a government borrows heavily in the present, it is doing so at the expense of the future.

Very often governments require so much cash that they are forced to borrow money from foreigner entities. By taking outside loans, governments place themselves in a very vulnerable situation because of the volatility in the international monetary markets. Should foreign investors notice changes in the country's economy, such as a rise in the debt or a drop in the gross domestic product (GDP), they can force a change in the bond rating and a concomitant increase in interest rates. They may also start shedding the country's currency, lowering its value.

Selected full-text books and articles on this topic

Monetary vs. Fiscal Policy
Milton Friedman; Walter W. Heller.
W.W. Norton, 1969
Do Deficit$ Matter?
Daniel Shaviro.
University of Chicago Press, 1997
Facing Tough Choices: Balancing Fiscal and Social Deficits
Steven R. Eastaugh.
Praeger Publishers, 1994
Fiscal Policy, Past and Present
Auerbach, Alan J.
Brookings Papers on Economic Activity, No. 1, Spring 2003
Growth, Income Inequality, and Fiscal Policy: What Are the Relevant Trade-Offs?
Garcia-Penalosa, Cecilia; Turnovsky, Stephen J.
Journal of Money, Credit & Banking, Vol. 39, No. 2-3, March-April 2007
The Effects of Fiscal Policy in a Two-Country World Economy: An Intertemporal Analysis
Lee, Yeonho.
Journal of Money, Credit & Banking, Vol. 27, No. 3, August 1995
Fiscal Policy and Presidential Elections: Update and Extension
Cuzan, Alfred G.; Bundrick, Charles M.
Presidential Studies Quarterly, Vol. 30, No. 2, June 2000
Monetary and Fiscal Policy Switching
Chung, Hess; Davig, Troy; Leeper, Eric M.
Journal of Money, Credit & Banking, Vol. 39, No. 4, June 2007
A Decade of Deficits: Congressional Thought and Fiscal Action
Steven E. Schier.
State University of New York Press, 1992
Fiscal Policy Convergence from Reagan to Blair: The Left Veers Right
Ravi K. Roy; Arthur T. Denzau.
Routledge, 2003
Fiscal Policy and EMU
Allsopp, Christopher; Vines, David.
National Institute Economic Review, No. 158, October 1996
Fiscal Deficit in the Pacific Region
Akira Kohsaka.
Routledge, 2004
Public Sector Economics for Developing Countries
Michael Howard.
University Press of the West Indies, 2001
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