Fiscal Policy is a method which is used to keep the level of inflation under control and to stabilize the economy. It’s different approach to the Monetary Policy approach. While Monetary Policy is a soft approach in dealing with inflation, Fiscal Policy is a harsh approach towards inflation.
Fiscal Policy deals with taxation measures and Govt spending to be taken to keep the inflation from bursting out. A change in the level and composition of taxation and Govt spending can impact some variables in the economy. They are aggregate demand and the level of economic activity, the pattern of resource allocation and the distribution of income. Fiscal policy refers to the overall effect of the budget outcome on economic activity.
Budget Deficits and Surpluses: When government expenditures exceed government tax revenues in a given year, the government is running a budget deficit. The budget deficit, which is the difference between government expenditures and tax revenues, is financed by government borrowing; the government issues long-term, interest-bearing bonds and uses the proceeds to finance the deficit. The total stock of government bonds and interest payments outstanding, from both the present and the past, is known as the national debt. Thus, when the government finances a deficit by borrowing, it is adding to the national debt. When government expenditures are less than tax revenues in a given year, the government is running a budget surplus for that year.
The Budget Surplus is the difference between tax revenues and government expenditures. The revenues from the budget surplus are typically used to reduce any existing national debt. In the case where government expenditures are exactly equal to tax revenues in a given year, the government is running a balanced budget for that year.
Detailed Explanation of Fiscal Policy
Expansionary and Contractionary Fiscal Policy:
Expansionary Fiscal Policy is defined as an increase in government expenditures and/or a decrease in taxes that causes the government’s budget deficit to increase or its budget surplus to decrease.
Contractionary Fiscal Policy is defined as a decrease in government expenditures and/or an increase in taxes that causes the government’s budget deficit to decrease or its budget surplus to increase.
Classical and Keynesian views of Fiscal Policy: The belief that expansionary and contractionary fiscal policies can be used to influence macroeconomic performance is most closely associated with Keynes and his followers. The classical view of expansionary or contractionary fiscal policies is that such policies are unnecessary because there are market mechanisms—for example, the flexible adjustment of prices and wages—which serve to keep the economy at or near the natural level of real GDP at all times. Accordingly, classical economists believe that the government should run a balanced budget each and every year.
Combating a recession using expansionary fiscal policy. A fiscal policy in which a decrease in government purchases, an increase in taxes, and/or a decrease in transfer payments are used to correct the inflationary problems of a business-cycle expansion. The goal of contractionary fiscal policy is to close an inflationary gap, restrain the economy, and decrease the inflation rate. Contractionary fiscal policy is often supported by contractionary monetary policy. An alternative is expansionary fiscal policy.
Combating inflation using contractionary fiscal policy: A form of fiscal policy in which an increase in government purchases, a decrease in taxes, and/or an increase in transfer payments are used to correct the problems of a business-cycle contraction. The goal of expansionary fiscal policy is to close a recessionary gap, stimulate the economy, and decrease the unemployment rate. Expansionary fiscal policy is often supported by expansionary monetary policy. An alternative is contractionary fiscal policy.
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