Fiscal policy represents the government’s ability to influence the economy through taxation and spending. By using tools known as ‘automatic stabilizers’, the government is able to control the fluctuations in the economy, and ensure that the business cycles therein are stabilized. The objective of these policies is to then both influence the application of funds that are directly minted in an expansionary monetary policy, and to ensure that government incomes are balanced with appropriate outflows.
In general, the goals of fiscal policies surround the stimulation of demand through either encouraging or discouraging demand. This is accomplished by examining the impacts of certain measures in light of a figure known as the market’s marginal propensity of consume. The MPC measures the market’s willingness to spend each new dollar they earn from a fiscal policy.
If the government provides consumers with a $100 tax break, in an environment that has an 80% MPC, the consumers will likely spend $80, and save the other $20. These funds will then be impacted by the money multiplier effect, and increase the supply of money available within the economy as a whole. Using this metric, a government is able to understand exactly how much of an impact a given measure will have on the economy as a whole, therefore how much of a measure needs to be implemented.
The strategies that governments will use for enacting fiscal policies vary, but do tend to fall within a few key categories. Tax policies are the most obvious of fiscal policies, in that they directly impact how much money consumers have in their pockets, or left over after a purchase. From there, Taxes scale in a way that only impacts consumers that are either earning money, or are purchasing goods. This means that only sales taxes will impact the extremely poor. Additionally, taxes can be easily refunded in a way that places funds back in the hands of consumers right away.
The alternative fiscal strategies that governments will use impact the economy include transfer payments to redistribute wealth from tax programs to the impoverished (such as social security and unemployment insurance), subsidies to goods and services, and capital spending programs. While more directly impacting specific aspects of the economy, these strategies have become more relevant in the modern economy, as stimulus and industry bail-out packages become increasingly meaningful to the overall markets.
Looking at how it is that Fiscal policy can directly impact the economy by increasing the supply of money available to markets, we can now take a look at how it is that these measures combine with monetary policies to take actions towards the government’s overall economic strategy of either expanding or contracting the economy as a whole.