Views on Us Fiscal Policy

Fiscal Policy

Fiscal policy is the use of government spending and taxation to influence the economy. When the government decides on the goods and services it purchases, the transfer payments it distributes, or the taxes it collects, it is engaging in fiscal policy.

There are multiple types of fiscal policy. The first type, Expansionary fiscal policy, may be needed when a recession occurs. This policy consists of spending increases and or tax reductions which is designed to increase aggregate demand which in turn, should raise real GDP. There are three main options within an expansionary fiscal policy. The first being to increase government spending. Other things equal, a sufficient increase in government spending should shift an economy's aggregate demand curve to the right which should in turn increase the economy's real GDP which , in time, should pull them out of the recession. Along with the initial increase, through the multiplier effect the aggregate demand curve will shift even farther right which exceeds the original increase in demand. The second option in an expansionary fiscal policy would be to reduce taxes. Cutting taxes will have basically the same effect as increasing spending just in a different way. If the government for instance, cut personal income taxes, this would increase disposable income by that same amount. Like increasing government spending, this would generate a larger aggregate demand which in turn increases real GDP. And as in increasing government spending, the multiplier process yields successive rounds of increased consumption spending. The third and final option in an expansionary fiscal policy is to combine increases in government spending and reduce taxes. As both of these do separately, together as well they will increase aggregate demand which will in turn increase real GDP.

The other form of fiscal policy is a restrictive or contractionary fiscal policy. This is used in the opposite situation that an expansionary policy is used. A contractionary policy is set in place when demand-pull inflation occurs. Again there are three options within the contractionary policy and as the policy is the opposite of the first one, the three options are the opposite as well. First, instead of increasing government spending as in expansionary policy, we decrease government spending to decrease aggregate demand. When aggregate demand is increased beyond equilibrium the initial increase will cause an inflationary GDP gap. In the case, instead of increasing output, this causes demand-pull inflation which in turn raises prices. In order to counteract this, a decrease in government spending will decrease the aggregate demand which will in turn bring prices back down to appropriate levels. It is also possible to for the government to increase taxes. Raising taxes will reduce consumption spending which in turn will shift the aggregate demand curve to the left which, after the multiplier effect, will close the inflationary gap and stop inflation. And again, as in an expansionary policy, a combination of both decreased government spending and an increase in taxes will also get the job done in eliminating inflation.

The principle objective of fiscal policy is to stabilize incomes, consumption, and investment. The general agreement is that boosting aggregate demand is the proper objective. There is some disagreement on the exact method by which aggregate demand can be expanded, but generally the policy response would include an automatic and a discretionary component. Government spending expands automatically in recessions with the increase in unemployment insurance, welfare benefits, and other transfers to the jobless and the poor. In addition, tax revenues decline with the fall in economic activity, thus boosting the countercyclical government deficit. Furthermore, a number of discretionary moves can be undertaken to hasten the recovery. These normally include additional tax cuts to households and businesses, as well as direct aid to states and firms in the form of grants, contracts, and loans for the purposes of new investment.

Since the economy began to falter in 2007, Congress has passed what amounts to three stimulus bills; a bipartisan $158 billion package of tax cuts