Fiscal policy refers to the government's use of revenue generation and spending strategies to control public revenue and expenditure, and ultimately influence the national economy. This policy can be expansionary or contractionary. While it can be used effectively to reduce budget deficits, combat unemployment and increase domestic consumption, it usually takes some time to be implemented and can give rise to conflicts between objectives.
Fiscal Policy Advantages
- Unemployment Reduction – When unemployment is high, the government can employ an expansionary fiscal policy. This involves increasing spending or purchases and lowering taxes. Tax cuts, for example, can mean people have more disposable income, which should lead to increased demand for goods and services. To meet the growing demand, the private sector will increase production, creating more job opportunities in the process.
- Budget Deficit Reduction - A country has a budget deficit when its expenditures exceeds revenue. Since the economic effects of this deficit include increased public debt, the country can pursue contraction in its fiscal policy. It will, therefore, reduce public spending and increase tax rates to raise more revenue and ultimately lower the budget deficit.
- Economic Growth Increase - The various fiscal measures a country employs facilitate expansion of the national economy. For example, when the government reduces tax rates, businesses and individuals will have a greater incentive to invest and steer the economy forward. To boost the U.S. economy during the Great Recession in 2008, for instance, the government enacted the Economic Stimulus Act of 2008, which provided a range of fiscal measures, including tax incentives to encourage business investment.
Fiscal Policy Disadvantages
- Conflict of Objectives -- When the government uses a mix of expansionary and contractionary fiscal policy, a conflict of objectives can occur. If the national government wants to raise more money to increase its spending and stimulate economic growth, it can issue bonds to the public. Since government bonds offer a range of benefits to buyers, individuals and businesses will buy them heavily. According to the Michigan Institute of Technology, the private sector consequently will have little money left to invest. With reduced investment activity, the economy can slow down.
- Inflexibility - There are usually delays in the implementation of fiscal policy, because some proposed measures may have to go through legislative processes. A good demonstration of implementation delays is illustrated by the Great Recession. According to the National Bureau of Economic Research, it began in December 2007, and the country was only able to enact the Economic Stimulus Act in February 2008. Even when the government increases its spending, it takes some time before the money trickles down to people's pockets.
- MIT: Crowding Out
- NBER: US Business Cycle Expansions and Contractions
- Economics Help: The Effect of Tax Cuts
- Investopedia: What is the Effect of a Fiscal Deficit on the Economy?
- MIT Departments of Economics: The Economic Stimulus Payments of 2008 and the Aggregate Demand for Consumption
- Nasdaq: Advantages Of Bonds