Instead, the preferred tool for reining in unsustainable growth is usually a contractionary monetary policy , or raising interest rates and restraining the supply of money and credit in order to rein in inflation. Fiscal policy is enacted by a government. This is opposed to monetary policy, which is enacted through central banks or another monetary authority. In the United States, fiscal policy is directed by both the executive and legislative branches.
In the executive branch, the two most influential offices in this regard belong to the President and the Secretary of the Treasury , although contemporary presidents often rely on a council of economic advisers as well. In the legislative branch, the U. Congress authorizes taxes, passes laws, and appropriations spending for any fiscal policy measures through its "power of the purse". This process involves participation, deliberation, and approval from both the House of Representatives and the Senate.
Fiscal policy tools are used by governments that influence the economy. These primarily include changes to levels of taxation and government spending. To stimulate growth, taxes are lowered and spending is increased, often involving borrowing through issuing government debt.
To put the dampers on an overheating economy, the opposite measures would be taken. The effects of any fiscal policy are not often the same for everyone. Depending on the political orientations and goals of the policymakers, a tax cut could affect only the middle class, which is typically the largest economic group. In times of economic decline and rising taxation, it is this same group that may have to pay more taxes than the wealthier upper class.
Similarly, when a government decides to adjust its spending, its policy may affect only a specific group of people. A decision to build a new bridge, for example, will give work and more income to hundreds of construction workers. A decision to spend money on building a new space shuttle, on the other hand, benefits only a small, specialized pool of experts and firms, which would not do much to increase aggregate employment levels.
One of the biggest obstacles facing policymakers is deciding how much direct involvement the government should have in the economy and individuals' economic lives. Indeed, there have been various degrees of interference by the government over the history of the United States. But for the most part, it is accepted that a certain degree of government involvement is necessary to sustain a vibrant economy, on which the economic well-being of the population depends.
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Investing During a Recession. History of Recessions. Recession Terms A-F. Recession Terms G-Z. If, however, the government spends more than it collects in taxes, its fiscal policy is expansionary.
Such a policy can be the result of a deliberate plan to accelerate economic activity or the government may simply be unable balance its books. As a general rule, the more the government spends, the better off the business owner.
More government spending means more government jobs, which translates to more consumer spending. A great deal of government spending goes through independent contractors for such things as building roads, bridges and so forth. These contractors and their employees are also consumers of various goods and services, further adding to demand. Especially if higher government spending is coupled with lower corporate taxes, as part of an aggressive expansionary fiscal policy, small businesses will enjoy greater sales while paying less to the tax authority, resulting in excellent net profits.
Tight fiscal policy calls for less spending and more taxes, both of which hit the bottom line of the small business. To spend less, governments usually lay off workers or at the very least freeze hiring of new employees. Contracts are scaled down, while some projects that are not highly critical are put on hold or cancelled.
All of these factors result in less money injected into the system and less spending by both consumers and corporations. Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy. It is the sister strategy to monetary policy through which a central bank influences a nation's money supply.
These two policies are used in various combinations to direct a country's economic goals. Here's a look at how fiscal policy works, how it must be monitored, and how its implementation may affect different people in an economy. Before the Great Depression , which lasted from October 29, , to the onset of America's entry into World War II, the government's approach to the economy was laissez-faire.
Following World War II, it was determined that the government had to take a proactive role in the economy to regulate unemployment, business cycles , inflation, and the cost of money. By using a mix of monetary and fiscal policies depending on the political orientations and the philosophies of those in power at a particular time, one policy may dominate over another , governments can control economic phenomena. Fiscal policy is based on the theories of British economist John Maynard Keynes.
Also known as Keynesian economics , this theory basically states that governments can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending. Fiscal policy plays a very important role in managing a country's economy. For example, in many worried that the fiscal cliff , a simultaneous increase in tax rates and cuts in government spending set to occur in January , would send the U.
The U. The idea is to find a balance between tax rates and public spending. For example, stimulating a stagnant economy by increasing spending or lowering taxes, also known as expansionary fiscal policy, runs the risk of causing inflation to rise.
This is because an increase in the amount of money in the economy, followed by an increase in consumer demand, can result in a decrease in the value of money—meaning that it would take more money to buy something that has not changed in value.
Let's say that an economy has slowed down. Unemployment levels are up, consumer spending is down, and businesses are not making substantial profits. A government may decide to fuel the economy's engine by decreasing taxation, which gives consumers more spending money while increasing government spending in the form of buying services from the market such as building roads or schools.
By paying for such services, the government creates jobs and wages that are in turn pumped into the economy. Pumping money into the economy by decreasing taxation and increasing government spending is also known as " pump priming.
With more money in the economy and less taxes to pay, consumer demand for goods and services increases. This, in turn, rekindles businesses and turns the cycle around from stagnant to active. If, however, there are no reins on this process, the increase in economic productivity can cross over a very fine line and lead to too much money in the market.
This excess in supply decreases the value of money while pushing up prices because of the increase in demand for consumer products.
Hence, inflation exceeds the reasonable level. For this reason, fine-tuning the economy through fiscal policy alone can be a difficult, if not improbable, means to reach economic goals. If not closely monitored, the line between a productive economy and one that is infected by inflation can be easily blurred.
When inflation is too strong, the economy may need a slowdown. In such a situation, a government can use fiscal policy to increase taxes to suck money out of the economy.
Fiscal policy could also dictate a decrease in government spending and thereby decrease the money in circulation. Of course, the possible negative effects of such a policy, in the long run, could be a sluggish economy and high unemployment levels.
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