Macroeconomics – Fiscal Policy Hold your excitement.*

Fiscal policy refers to how government taxing and spending policy can be used to influence the macroeconomy. It has nothing to do with Nazi dictators and dancing cats.*

Ye olde definition Fiscal policy is the changes in the expenditures or tax revenues of the federal government, undertaken to promote full employment, price stability and reasonable rates of economic growth.*

Which means.. In the short term, fiscal policy can be used to reduce the extremes of recession and inflation. *

And… If the economy is in recession, then an expansionary fiscal policy can increase aggregate demand through some combination of tax cuts and/or spending increases. In English that means increasing output and cutting unemployent.*

On the other hand If an economy is suffering inflation, then a contractionary fiscal policy can reduce aggregate demand through some combination of tax increases and/or spending cuts. In English that means decreasing aggregate demand in the economy and controlling inflation.*

So? Fiscal policy can be misused and have unintended consequences or side effects. But that would imply the leaders in our government weren’t looking out for us or working in our best interests.

If a highly expansionary policy of tax cuts and/or spending increases is used at a time when the economy is not in a recession, it can increase aggregate demand in a way that leads to inflation.*

If a contractionary fiscal policy of tax increases and/or spending cuts reduces aggregate demand when an economy is already in or near recession, it can make the recession deeper and longer.*

An increase in taxes can also affect people's willingness to work, save and invest, and this could cause a decrease in economic growth.*

Fiscal Policy vs Monetary Policy So, in some ways fiscal policy is similar to monetary policy in that they both try to promote growth, control inflation, and keep prices stable. But think of it this way: Monetary policy is an indirect approach. Fiscal Policy is a direct approach.