Fiscal Policy

Now that we’ve discussed monetary policy, let’s talk about fiscal policy. Fiscal policy is what the federal government can do to help the economy. The federal government only has two tools to help the economy. It can either change taxes or change its spending.

The first way the federal government can aid the economy is by setting tax rates. The government can either raise or lower tax rates. Suppose the economy is performing poorly and the government wants to stimulate economic activity, it can then lower the tax rate. This reduction decreases the amount that businesses and individuals have to pay in taxes. The businesses then have more money to spend, which increases the money supply.

The second tool the government has is setting the government budget. If the government wants to increase spending, it can enter into deficit spending. Conversely, if it wants to decrease spending, it enters into surplus spending.

Suppose the economy is performing poorly, and the government enters into deficit spending. The government, therefore, hires many businesses. The government spends more and pays more to those businesses, enabling these businesses to earn more money and hire more employees. This results in a decrease in unemployment. Since people are now earning more, the money supply increases.

In summary, if the government wants to stimulate economic growth, it will spend more and enter into deficit spending. If it wants to suppress economic growth, it’ll enter into surplus spending.

Study Tip: The federal government can raise/lower tax rates and enter into deficit/ surplus spending to regulate the economy’s activity.