Fiscal Policy, a very vital part of economics, is referred to as the government spending as well as revenue collection of a country.
Fiscal Policy has two main instruments that are;
• Government spending
There are certain changes in the composition and level of government spending and taxation that impact the following variables in the economy of a country:
• Aggregate demand and the level of economic activity.
• Resource allocation pattern.
• Distribution of income.
The overall effect of the budget outcome on an economic activity is termed as Fiscal policy of a country. There are three particular stances regarding the fiscal policy of a country that are; neutral, expansionary and contractionary:
• A neutral stance regards a balanced budget where “Government spending = Tax revenue” (G = T). The government spending is funded by tax revenue and the overall effect of the budget outcome is neutral on the economic activity.
• Expansionary stance of the fiscal policy denotes a net increase in Government spending (G > T) through rises in government spending or a fall in taxation revenue or a combination of the two. The effect usually leads to a larger budget deficit or a smaller budget surplus than the Government previously had, or a deficit if the Government previously had a balanced budget. Expansionary fiscal policy is mostly associated with budget deficit for an economy.
• Contractionary fiscal policy (G < T) involves the reduction of the Government spending through higher taxation revenue or reduced Government spending or the combination of the two in such a way. This leads to a lower budget deficit or a larger surplus than the Government previously had, or a surplus if the government previously had a balanced budget. Contractionary fiscal policy is usually associated with a surplus.
The government spends money on a wide variety of things, from the military and police to services like healthcare and education, as well as transfer payments that stand as welfare benefits. This expenditure can be funded in a number of ways:
• Benefit from printing money
• Borrowing money from the population that results in a fiscal deficit.
• Consumption of reserves.
• Sale of assets i-e land etc.
There are two ways for the budgeting to go, one is that the Government will face deficit, and the other, it will face a surplus, these are the basic form of effects the Government spending have of course.
A fiscal deficit is often funded by issuing secure bonds such as treasury bills. These pay interest, either for a fixed period or indefinitely. The nation may default on its debt if the interest and capital repayments are too large. This is how a Government funds the deficit.
A fiscal surplus is usually saved for future use, and may be invested in local instruments, till needed. When income from taxation or other sources falls, usually during an economic crash, reserves allow Government spending to continue at the same rate, without gaining additional liabilities.
Economic Effects of Fiscal Policy
Fiscal policy is used by governments to influence the level of aggregate demand in the economy, in an effort to achieve economic objectives of stability in the price of goods, employment and the economic growth of the country. Keynesian (John Maynard Keynes) economics suggests that increasing or decreasing the Government spending and the tax rates to stimulate aggregate demand as a favorable outcome. This is usually used in times of recession or low economic activity as an essential tool in providing the framework for strong economic growth and working toward full employment. The Government usually implements such deficit-spending policies due to its size and reputation and stimulates trade. In theory, these deficits would be paid for by an expanded economy during the boom that would follow.
During high economic growth periods, budget surplus is usually used to decrease activity in the economy. A budget surplus will be implemented in the economy if inflation is high, in order to achieve the objective of price stability. According to Keynesian theory, the removal of funds from the economy will reduce levels of aggregate demand in the economy and contract it that will bring stability in the price level.