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Fiscal Policy

Overview

In simple terms, fiscal policies are government spending and income collection policies that influence the interest rates, tax rates in an effort to control the economy. Fiscal policy acts in contrast with monetary policy whereby the latter tries to stabilize the economy by controlling the supply of money and the interest rates. In other words, fiscal policy can be termed as the overall effect of the financial plan outcome on the economic activity.

The principle instruments of fiscal policy are taxation and government spending. This is to say that alterations in both or either taxation and government spending impacts on variables in the economy, such as income distribution, resource allocation pattern and it aggregates demand and the economic activity level.

Depiction of fiscal policy

Like the monetary policy, fiscal policy can likewise be described in three broad stances; first, the neutral posture or stance is whereby the fiscal policy implies there is an impartial, a fair budget in that the government spending equals the tax revenue. Since government spending is directly funded by tax revenue, the overall financial plan or budget would therefore have a neutral outcome on the level of the economy.

Expansionary posture or stance is the second description of fiscal policy which entails a net increase in government spending, caused by a fall in taxation revenue or escalates in government spending, or both of them combined, resulting in a budget deficit. If the preceding budget of the government was balanced, expansionary stance will result in a budget deficit. Basically, it can result in a bigger budget deficit or a lesser budget surplus than the preceding budget.

The third stance is contractionary, the opposite of expansionary stance. This stance means that the net government spending decreases either due to higher taxation revenue or a decreased government spending or both of them combined. The results would mean that the government would either have a lower or larger budget deficit and surplus respectively than the preceding budget. And if the government had a balanced budget previously, it may lead to a budget surplus.

Ways of funding

Typically, the expenditure of the government entails funding a wide array of things such as financing the military and financing services such as healthcare and education in addition to transferring remunerations such as welfare benefits. The funding of these and other things can be done through printing of new money, taxation, sales of property, consuming fiscal reserves and borrowing money from the population, which of course will result in a fiscal deficit.

Fiscal deficit is funded through the issuance of bonds whereby they pay interest for an indefinite or a fixed period of time. Typically, fiscal surplus is rationally saved for future use; hence it can be invested in local financial instruments until the time comes when the earnings from taxation or from other sources will reduce. This allows the government spending to continue as normal, without incurring a budget deficit.

Economic effects of fiscal policy

It is believed that the government uses fiscal policy to manipulate and stimulate the level of aggregate demand, with an effort to achieve its economic objectives which are mainly economic growth, the stability of prices and full employment.

By the same token, during high economic growth periods, the government can make use of a budget surplus to decrease escalating economic activities which will result to inflation, hence attaining price stability.

However, according to some economists, fiscal policy can lack stimulus effect. This argument is based on the fact that when a government has a budget deficit; it results in foreign borrowing, public borrowing or printing of new money hence increasing interest rates across the market.

Tags: government, Income, interest rates, market, money, policy, price, revenue, Stimulus, tax, Taxation

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