Fiscal policy meaning in english

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fiscal policy meaning in english

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fiscal policy meaning in english

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Statistics for fiscal policy Look-up Popularity. Get Word of the Day daily email! Test Your Vocabulary. Test your visual vocabulary with our question challenge! A daily challenge for crossword fanatics. Need even more definitions? The awkward case of 'his or her'. Take the quiz Name That Thing Test your visual vocabulary with our question Play the game.Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy.

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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 Depressionwhich 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 cyclesinflation, 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 anothergovernments can control economic phenomena.

Fiscal policy is based on the theories of British economist John Maynard Keynes. Also known as Keynesian economicsthis theory basically states that governments can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending. The U. 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.

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.

Fiscal policy

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. 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. Nonetheless, the process continues as the government uses its fiscal policy to fine-tune spending and taxation levels, with the goal of evening out the business cycles. Unfortunately, the effects of any fiscal policy are not 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.Fiscal policy refers to the measures taken by the government to influence the economy, especially through adjusting the levels of spending and taxes.

Government employs fiscal policy in an economy to influence the level of aggregate demand to attain the economic objectives of full employmentprice stability and economic growth. The government usually make adjustments in fiscal policy when an economy is going down on aggregate demand and when the unemployment rate is high.

fiscal policy meaning in english

To make these alterations, the government has two key instruments at its disposal, as listed below:. Taxation : The government modifies the structure of tax rates in line with the circumstances prevailing in an economy. With the change in tax rates, the government is able to sway the average income of consumers, which further influences the level of consumption and real GDP. Government Spending : Similar to taxation, government spending also carries the potential to increase or reduce the economic activity.

The government utilises fiscal spending as a tool to stimulate public money flow to certain sectors that need an economic boost. Whoever obtains the funds from the government gets more money to spend, which in turn boosts aggregate demand and economic growth. While both fiscal and monetary policies are utilised to regulate economic activity over the course of time, the former is implemented by the government while the latter is conducted by the central bank.

Moreover, the two policies majorly differ over the type of tools utilised by their respective authorities to stimulate economic growth. While monetary policy primarily targets output, inflation and employment; the fiscal policy does not focus on a specific goal but a range of objectives, as stated below:.

Fiscal policy can be broadly categorised into two types — expansionary and contractionary fiscal policy. Expansionary Fiscal Policy : During a recession or an economic depressionthe government often intervenes in the economy through expansionary fiscal policy so as to alleviate the fall in aggregate demand. The expansionary fiscal policy involves a fall in tax revenue, a rise in government spending or a combination of these two elements to drive economic activity.

Here, increased government spending can be in the form of both purchase of goods and services by the government that directly improves economic activity, and transfers to people that indirectly stimulate economic activity when individuals spend those funds. Similarly, decreased tax revenue through tax cuts also bolsters aggregate demand indirectly.

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While the expansionary policy can lessen the negative impacts of recession on an economy, it can also trigger the following problems:. Contractionary Fiscal Policy : When the economy moves from recession to an expansion phase, policymakers may decide to withdraw the fiscal stimulus by applying the contractionary fiscal policy.

Such policy involves a rise in tax revenue, a fall in government spending or a combination of the two to slow economic activity temporarily. The reduced spending temporarily lowers aggregate demand, slowing economic growth for some time. Similarly, when the government reduces spending, it again lowers aggregate demand and economic growth temporarily. Akin to expansionary fiscal policy, the contractionary policy has its own caveats, as stated below:. It is important to note that monetary policy can be used in conjunction with fiscal policy t o limit the undesirable impacts of expansionary or contractionary fiscal policy.

The countercyclical fiscal policy is stated as a strategy taken by the government to deal with recession or boom via fiscal measures. For instance, during the Global Financial Crisis GFCthe governments across the world resorted to fiscal policy as a measure to improve the performance of economies.The government can use changes in its own expenditure to affect spending levels; for example, a cut in current purchases of products or capital investment by the government again serves to reduce total spending in the economy.

Taxation and government expenditure are linked together in terms of the government's overall fiscal or BUDGET position: total spending in the economy is reduced by the twin effects of increased taxation and expenditure cuts with the government running a budget surplus. If the objective is to increase spending then the government operates a budget deficit, reducing taxation and increasing its expenditure. In practice the application of fiscal policy as a short-term stabilization technique encounters a number of problems which reduces its effectiveness.

Taxation rate changes, particularly alterations to income tax, are administratively cumbersome to initiate and take time to implement: likewise, a substantial proportion of government expenditure on, for example schools, roads, hospitals and defence, reflect longer-term economic and social commitments and cannot easily be reversed without lengthy political lobbying.

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Practical experience has indicated that the short-termism approach to economic management has not in fact been especially successful in stabilizing the economy. As a result, medium-term management of the economy favoured by the monetarist school has, in recent years, assumed a greater degree of significance.

The government can use changes in its own expenditure to affect spending levels: for example, a cut in current purchases of products or capital investment by the government again serves to reduce total spending in the economy. Taxation and government expenditure are linked together in terms of the government's overall fiscal or BUDGET position: total spending in the economy is reduced by the twin effects of increased taxation and expenditure cuts with the government running a budget surplus see Fig.

If the objective is to increase spending, then the government operates a budget deficit, reducing taxation and increasing its expenditure. The use of budget deficits was first advocated by KEYNES as a means of counteracting the mass unemployment of the s and s. In practice, the application of fiscal policy as a short-term stabilization technique encounters a number of problems that reduce its effectiveness.

Taxation rate changes, particularly alterations to income tax, are administratively cumbersome to initiate and take time to implement; likewise, a substantial proportion of government expenditure on, for example, schools, roads, hospitals and defence reflects longer-term economic and social commitments and cannot easily be reversed without lengthy political lobbying. Experience of fiscal policy has indicated that the short-termism approach to demand management has not in fact been especially successful in stabilizing the economy.

Recently, the government has accepted that fiscal stability is an important element in the fight against inflation. For example, receipts from future increases in fuel taxes and tobacco taxes will be spent, respectively, only on road-building programmes and the National Health Service. Fiscal policy Government spending and taxing for the specific purpose of stabilizing the economy.

All Rights Reserved. Government policies related to taxes, spending, and interest rates. Fiscal policy is intended positively influence macroeconomic conditions. The primary debate within this field is how active a government should be.

Proponents of a tight fiscal policy argue that government acts best when it acts least; they promote low taxes and spending and ideally limit government involvement to the setting of prevailing interest rates. Proponents of a loose government policy believe that government has a larger role in promoting economic well-being.

See also: ReaganomicsKeynesian economics. Farlex Financial Dictionary. The existing policy the government has for spending and taxing. Fiscal policy directly affects economic variables, such as tax rates, interest rates, and government programs, that influence security prices.

See also monetary policy.

Fiscal Policy

Published by Houghton Mifflin Company. All rights reserved. Collins Dictionary of Business, 3rd ed. Collins Dictionary of Economics, 4th ed. Pass, B. Lowes, L. Davies Mentioned in?Fiscal policymeasures employed by governments to stabilize the economy, specifically by manipulating the levels and allocations of taxes and government expenditures. Fiscal measures are frequently used in tandem with monetary policy to achieve certain goals.

The usual goals of both fiscal and monetary policy are to achieve or maintain full employment, to achieve or maintain a high rate of economic growthand to stabilize prices and wages. The establishment of these ends as proper goals of governmental economic policy and the development of tools with which to achieve them are products of the 20th century.

The consequences of such actions are generally predictable: a decrease in personal taxationfor example, will lead to an increase in consumptionwhich will in turn have a stimulating effect on the economy. Similarly, a reduction in the tax burden on the corporate sector will stimulate investment. Steps taken to increase government spending by public works have a similar expansionary effect. Conversely, a reduction in government expenditure or an increase in tax revenues, without compensatory action, has the effect of contracting the economy.

Fiscal policy relates to decisions that determine whether a government will spend more or less than it receives. Under the balanced-budget regime, personal and business tax rates were raised during periods of declining economic activity to ensure that government revenues were not reduced. The effect of this was to reduce consumption still further, increase surplus industrial capacity, and depress investment, all of which exerted a downward pressure on the economy.

Alternatively, if, in order to maintain a balanced budget, taxes remained level but government expenditures were cut back during such a period of declining economic activity, a similar downward pressure was exerted.

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The Keynesian theory showed that, under certain conditions, the operation of market forces would not automatically generate full employment, and that governments should abandon the balanced-budget concept and adopt active measures to stimulate the economy.

Furthermore, to be really effective, these measures should be financed by government borrowing rather than by raising taxes or by cutting other government expenditures.

Initial experiments with this new stabilizing technique in the United States during the first term —37 of President Franklin D. With the advent of World War II and soaring government spending, the unemployment problem in the United States virtually disappeared. In the postwar period the use of fiscal policy changed somewhat. The problem was no longer massive unemployment but a persistent tendency to inflation against a backdrop of fairly rapid economic growth punctuated by short periods of shallow recession.

Since the days of Keynes, fiscal policy has been refined to smooth these cyclical movements. As a counterinflationary tool it has not been particularly effective, partly because of political constraints and partly because of the so-called automatic stabilizers at work. The political constraints arise from the fact that politicians have found it unpopular to raise taxes and cut government expenditure when the economy becomes overheated.

The automatic stabilizers in the economy inhibited the use of discretionary fiscal policy. For example, during a recession personal incomes will be shrinking, but, owing to the highly progressive tax system i. This will be accompanied by a decline in government tax revenues, and, so long as the government does not take steps to reduce expenditures to compensate for the loss of revenuethe net result will be to temper the decline in the level of economic activity.

Conversely, during a boom a disproportionate share of the additional income flows into the treasury, keeping the rate of consumption expenditures below the rate that might have otherwise prevailed in the absence of a progressive tax system.

Unemployment benefits produce a similar effect. During a recession unemployment benefits rise with the growing numbers of unemployed and prevent disposable incomes from falling by as much as would otherwise have been the case. This situation normally causes an increase in government expenditures and a decrease in tax revenue.

When the economy begins to expand again and demand for labour picks up, the unemployment pay drops automatically, tax revenue increases, and expenditures decrease. Fiscal policy Article Additional Info. Print Cite verified Cite. While every effort has been made to follow citation style rules, there may be some discrepancies. Please refer to the appropriate style manual or other sources if you have any questions.

Facebook Twitter. Give Feedback External Websites. Let us know if you have suggestions to improve this article requires login. External Websites. The Editors of Encyclopaedia Britannica Encyclopaedia Britannica's editors oversee subject areas in which they have extensive knowledge, whether from years of experience gained by working on that content or via study for an advanced degree See Article History.In economics and political sciencefiscal policy is the use of government revenue collection taxes or tax cuts and expenditure spending to influence a country's economy.

The use of government revenues and expenditures to influence macroeconomic variables developed as a result of the Great Depressionwhen the previous laissez-faire approach to economic management became unpopular.

Fiscal policy is based on the theories of the British economist John Maynard Keyneswhose Keynesian economics theorized that government changes in the levels of taxation and government spending influences aggregate demand and the level of economic activity. Fiscal and monetary policy are the key strategies used by a country's government and central bank to advance its economic objectives.

Changes in the level and composition of taxation and government spending can affect macroeconomic variables, including:.

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Fiscal policy can be distinguished from monetary policyin that fiscal policy deals with taxation and government spending and is often administered by a government department; while monetary policy deals with the money supplyinterest rates and is often administered by a country's central bank.

Both fiscal and monetary policies influence a country's economic performance. Since the s, it became clear that monetary policy performance has some benefits over fiscal policy due to the fact that it reduces political influence, as it is set by the central bank to have an expanding economy before the general election, politicians might cut the interest rates. Additionally, fiscal policy can potentially have more supply-side effects on the economy: to reduce inflation, the measures of increasing taxes and lowering spending would not be preferred, so the government might be reluctant to use these.

Monetary policy is generally quicker to implement as interest rates can be set every month, while the decision to increase government spending might take time to figure out which area the money should be spent on. The recession of the s decade shows that monetary policy also has certain limitations. A liquidity trap occurs when interest rate cuts are insufficient as a demand booster as banks do not want to lend and the consumers are reluctant to increase spending due to negative expectations for the economy.

Government spending is responsible for creating the demand in the economy and can provide a kick-start to get the economy out of the recession. When a deep recession takes place, it is not sufficient to rely just on monetary policy to restore the economic equilibrium. These policies have limited effects; however, fiscal policy seems to have a greater effect over the long-run period, while monetary policy tends to have a short-run success.

Ina survey of members of the American Economic Association AEA found that while 84 percent generally agreed with the statement "Fiscal policy has a significant stimulative impact on a less than fully employed economy", 71 percent also generally agreed with the statement " Management of the business cycle should be left to the Federal Reserve ; activist fiscal policy should be avoided.

Depending on the state of the economy, fiscal policy may reach for different objectives: its focus can be to restrict economic growth by mediating inflation or, in turn, increase economic growth by decreasing taxes, encouraging spending on different projects that act as stimuli to economic growth and enabling borrowing and spending. The three stances of fiscal policy are the following:. However, these definitions can be misleading because, even with no changes in spending or tax laws at all, cyclic fluctuations of the economy cause cyclic fluctuations of tax revenues and of some types of government spending, altering the deficit situation; these are not considered to be policy changes.

Therefore, for purposes of the above definitions, "government spending" and "tax revenue" are normally replaced by "cyclically adjusted government spending" and "cyclically adjusted tax revenue". Thus, for example, a government budget that is balanced over the course of the business cycle is considered to represent a neutral and effective fiscal policy stance. Governments spend money on a wide variety of things, from the military and police to services such as education and health care, as well as transfer payments such as welfare benefits.

This expenditure can be funded in a number of different ways:. A fiscal deficit is often funded by issuing bondssuch as Treasury bills or and gilt-edged securities. These pay interest, either for a fixed period or indefinitely. If the interest and capital requirements are too large, a nation may default on its debts, usually to foreign creditors.

Public debt or borrowing refers to the government borrowing from the public. A fiscal surplus is often saved for future use, and may be invested in either local currency or any financial instrument that may be traded later once resources are needed and the additional debt is not needed. The concept of a fiscal straitjacket is a general economic principle that suggests strict constraints on government spending and public sector borrowing, to limit or regulate the budget deficit over a time period.

Most US states have balanced budget rules that prevent them from running a deficit. The United States federal government technically has a legal cap on the total amount of money it can borrowbut it is not a meaningful constraint because the cap can be raised as easily as spending can be authorized, and the cap is almost always raised before the debt gets that high.

Governments use fiscal policy to influence the level of aggregate demand in the economy, so that certain economic goals can be achieved:. The Keynesian view of economics suggests that increasing government spending and decreasing the rate of taxes are the best ways to have an influence on aggregate demand, stimulate it, while decreasing spending and increasing taxes after the economic expansion has already taken place. Additionally, Keynesians argue that expansionary fiscal policy should be used in times of recession or low economic activity as an essential tool for building the framework for strong economic growth and working towards full employment.

In theory, the resulting deficits would be paid for by an expanded economy during the expansion that would follow; this was the reasoning behind the New Deal.

Governments can use a budget surplus to do two things:. Keynesian theory posits that removing spending from the economy will reduce levels of aggregate demand and contract the economy, thus stabilizing prices.Fiscal policy refers to the use of government spending and tax policies to influence economic conditionsespecially macroeconomic conditions, including aggregate demand for goods and services, employment, inflation, and economic growth.

Fiscal policy is largely based on the ideas of British economist John Maynard Keyneswho argued that economic recessions are due to a deficiency in the consumption spending and business investment components of aggregate demand.

Keynes believed that governments could stabilize the business cycle and regulate economic output by adjusting spending and tax policies to make up for the shortfalls of the private sector.

His theories were developed in response to the Great Depression, which defied classical economics' assumptions that economic swings were self-correcting. Keynes' ideas were highly influential and led to the New Deal in the U.

In Keynesian economicsaggregate demand or spending is what drives the performance and growth of the economy. Aggregate demand is made up of consumer spending, business investment spending, net government spending, and net exports. According to Keynesian economists, the private sector components of aggregate demand are too variable and too dependent on psychological and emotional factors to maintain sustained growth in the economy.

Pessimism, fear, and uncertainty among consumers and businesses can lead to economic recessions and depressions, and excessive exuberance during good times can lead to an overheated economy and inflation.

However, according to Keynesians, government taxation and spending can be managed rationally and used to counteract the excesses and deficiencies of private sector consumption and investment spending in order to stabilize the economy. This means that to help stabilize the economy, the government should run large budget deficits during economic downturns and run budget surpluses when the economy is growing. These are known as expansionary or contractionary fiscal policies, respectively. To illustrate how the government can use fiscal policy to affect the economy, consider an economy that's experiencing a recession.

The government might issue tax stimulus rebates to increase aggregate demand and fuel economic growth. The logic behind this approach is that when people pay lower taxes, they have more money to spend or invest, which fuels higher demand.

That demand leads firms to hire more, decreasing unemploymentand to compete more fiercely for labor. In turn, this serves to raise wages and provide consumers with more income to spend and invest.

It's a virtuous cycle, or positive feedback loop. Rather than lowering taxes, the government may seek economic expansion through increases in spending without corresponding tax increases.

What Is Fiscal Policy?

By building more highways, for example, it could increase employment, pushing up demand and growth. Expansionary fiscal policy is usually characterized by deficit spendingwhen government expenditures exceed receipts from taxes and other sources. In practice, deficit spending tends to result from a combination of tax cuts and higher spending.

Mounting deficits are among the complaints lodged about expansionary fiscal policy, with critics complaining that a flood of government red ink can weigh on growth and eventually create the need for damaging austerity. Many economists simply dispute the effectiveness of expansionary fiscal policies, arguing that government spending too easily crowds out investment by the private sector.

Expansionary policy is also popular—to a dangerous degree, say some economists. Fiscal stimulus is politically difficult to reverse. Whether it has the desired macroeconomic effects or not, voters like low taxes and public spending.

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