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Definition of Fiscal Policy

Fiscal policy is generally considered to be the act of a government body in using its financial or regulatory powers to impact the nation’s economy. By government we generally mean either the executive branch (president or prime minister) or the congress (parliament).  These financial powers derive from the government’s ability to spend and tax.

Regulatory powers imply the ability of a government, without taxing or spending, to influence or require its people to change their behavior. For example, a government might require all business firms to produce safer or cleaner products.

Impacting the nation’s macroeconomic performance is only one part of a government’s goals: Most governments have very broad goals and missions that include at least the following:

  • justice
  • defense
  • security
  • transportation
  • healthcare
  • income security
  • pensions
  • education
  • communications
  • freedom from pollution
  • postal services.

Amongst these goals are also responsibilities to the overall economic environment – both in the short-term and the long-run. Short-run responsibilities include keeping today’s real GDP near or at its potential, and keeping the inflation and unemployment rates low.  Long-term policy is more aimed at the future growth rate of potential GDP – making it big enough so that future workers find jobs and so that the standard of living grows at a strong and sustainable pace.

Fiscal Policy and AD

Until the Great Depression of the 1930s it was generally thought that governments had little responsibility for correcting changes in the macroeconomic economy. Economists believed that something like Adam Smith’s “invisible hand” would operate, implying that most undesirable changes in AD would be self-correcting and temporary. The Great Depression started a counter-movement, sometimes called Keynesian economics after its leader, John M. Keynes. This movement established the idea that AD might not be self-correcting and that it was the responsibility of government to use its fiscal tools (Keynes had a preference for fiscal over monetary solutions for the Great Depression) to correct AD imbalances. Since at least the early 1960s, governments around the world have used changes in taxes, spending, and regulation on several occasions to impact AD.

Fiscal Policy Tools

Most of the focus on fiscal policy is on government’s ability to spend and tax. A good source of detailed background information about how the US government taxes and spends is:  The Congressional Budget Office (CBO) Budget Outlook. Full CBO publication is found at: http://www.cbo.gov/doc.cfm?index=12039

The following link from the St. Louis Federal Reserve Bank has several graphs and a table with current data on U.S. government spending and taxation. The big table below taken from the link also brings up the fact that U.S. government finances are described using two sets of similar but not exactly the same data for federal fiscal concepts – the National Income Accounts and the Unified Budget. http://research.stlouisfed.org/publications/net/page16.pdf

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One important distinction is that the NIA budget refers to the regular calendar year. The Unified Budget relates to the government’s fiscal year (from October 1 to September 30). It is more typical to see announcements of the Unified Budget figures.