In economics, fiscal policy is the use of government spending and revenue collection to influence the economy.[1]
Fiscal policy can be contrasted with the other main type of economic policy, monetary policy Monetary policy is the process by which the government, central bank, or monetary authority of a country controls the supply of money, (ii) availability of money, and (iii) cost of money or rate of interest, in order to attain a set of objectives oriented towards the growth and stability of the economy. Monetary theory provides insight into how to, which attempts to stabilize the economy by controlling interest rates and the supply of money Money is anything that is generally accepted as payment for goods and services and repayment of debts. The main functions of money are distinguished as: a medium of exchange, a unit of account, a store of value, and occasionally, a standard of deferred payment. The two main instruments of fiscal policy are government spending and taxation. Changes in the level and composition of taxation and government spending can impact on the following variables in the economy:
- Aggregate demand In economics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a country when inventory levels are static. It is often and the level of economic activity;
- The pattern of resource allocation;
- The distribution of income.
Fiscal policy refers to the overall effect of the budget outcome on economic activity. The three possible stances of fiscal policy are neutral, expansionary and contractionary:
- A neutral stance of fiscal policy implies a balanced budget where G = T (Government spending = Tax revenue). Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity.
- An expansionary stance of fiscal policy involves 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. This will lead 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 usually associated with a budget deficit.
- A contractionary fiscal policy (G < T) occurs when net government spending is reduced either through higher taxation revenue or reduced government spending or a combination of the two. This would lead 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 idea of using fiscal policy to combat recessions was introduced by John Maynard Keynes John Maynard Keynes, 1st Baron Keynes, CB (5 June 1883 – 21 April 1946) was a British economist whose ideas have been a central influence on modern macroeconomics, both in theory and practice. He advocated interventionist government policy, by which governments would use fiscal and monetary measures to mitigate the adverse effects of business in the 1930s, partly as a response to the Great Depression The Great Depression was a worldwide economic downturn starting in most places in 1929 and ending at different times in the 1930s or early 1940s for different countries. It was the largest and most severe economic depression in the 20th century, and is used in the 21st century as an example of how far the world's economy can decline. The Great.
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