Advantages and Disadvantages of Fiscal policy

Economics Online says the advantages of fiscal policy include that it can keep businesses afloat when household spending on consumer goods declines. Spending on military projects or on infrastructure can produce positive benefits besides economic growth. The Congressional Research Service says that in a recession, for example, demand drops, wages drop, employment shrinks and businesses make less money. Effective government spending can keep the economy from shrinking too much, which keeps people employed and businesses open. Governments likewise use fiscal policy to respond to natural disasters, spikes in food or fuel prices or to help citizens deal with problems such as expensive health care. Government fiscal policy uses spending, interest rates and taxes to influence the economy, reduce poverty and stimulate growth.

  1. The health of the economy overall is a complex equation, and no one factor acts alone to produce an obvious effect.
  2. By reacting proactively to economic indicators, governments can mitigate the impacts of recessions, ensuring shorter and less severe downturns.
  3. Under this policy, government expenditure is limited depending on the taxes collected.
  4. If there is the threat of an increase in the interest rate, then a company might decide to stall on their decision to expand operations.
  5. That means this option tends to work better when there are moments of expansion and growth when compared to recessions.
  6. In a nutshell, Keynes believed that the government’s budget should be in deficit when the economy is slowing and in surplus when economic growth is booming (usually accompanied by inflation).

Congress authorizes taxes, passes laws, and appropriations spending for any fiscal policy measures through its power of the purse. This process involves participation, deliberation, and approval from both the House of Representatives and the Senate. Federal Reserve Board and refers to actions taken to increase or decrease liquidity through the nation’s money supply. Expansionary policy is also popular—to a dangerous degree, say some economists.

Understanding Fiscal Policy

Public expenditure can be used to help stimulate the macro-economy at times of low and negative growth. It can also be used to complement monetary policy or when monetary policy has proved ineffective. This could be the case when interest rates are already low, but the economy still needs stimulating, as occurred throughout the advanced economies following the financial crisis and consequent global recession. Ideally, fiscal and monetary policy work together to create an economic environment in which growth remains positive and stable, while inflation remains low and stable.

Government spending has a bigger impact on aggregate demand than tax cuts. However, if the tax cuts are directed at the poorest of society, those who spend all their income, they are far more effective. While the overall goal of monetary and fiscal policy is generally the same—to influence the economy—there are inherent differences between the two. Monetary policy seeks to spark economic activity, while fiscal policy seeks to address either total spending, the total composition of spending, or both. If the spending is on capital items, then infrastructure can be developed, which can help improve competitiveness and economic growth. Infrastructure projects are usually far too expensive for the private sector to tackle on its own.

Can Direct Spending To Specific Purposes

When there is a global struggle to experience economic growth, then the tools that are in the toolbox of the central bank may not be useful. Even when there is the choice to lower interest rates during a worldwide recession, there are fewer export opportunities available because no one is spending as much money. That means you could potentially see steep declines in all sectors.

Create a Free Account and Ask Any Financial Question

As a result, the Federal Reserve is an independent agency of the federal government. Similarly, a potentially rapid and deep decrease in national income would be prevented by fiscal boost. Fiscal boost means as incomes fall in a recession the impact of falling incomes is softened as income earners pay proportionately lower taxes, and retain more post-tax income. President George W. Bush enacted the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Act of 2003.

Do you own a business?

Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications. Our work has been directly cited by organizations including Entrepreneur, Business Insider, Investopedia, Forbes, CNBC, and many others. This team of experts helps Finance Strategists maintain the highest level of accuracy and professionalism possible. Targeted approaches allow for efficient resource allocation, maximizing impact.

On a larger economic scale, this program can help prevent disposable incomes from dropping to low levels that risk further slowing the economy. A progressive tax system can also help smooth the economic cycle in times of expansion. A disproportionate share of taxes can boost the nation’s treasury while tempering spending activity from higher levels that might have resulted in the absence of a progressive tax system. One example is the progressive tax system, which disproportionately raises the tax rate on those generating higher incomes. As personal wages shrink during a recession, taxes collected through this system help cushion losses in consumers’ purchasing power, keeping more spending money in the hands of consumers.

Many economists simply dispute the effectiveness of expansionary fiscal policies. They argue that government spending too easily crowds out investment by the private sector. To illustrate how the government can use fiscal policy to affect the economy, consider an economy that’s experiencing a recession.

Even when the alterations occur rapidly, the effects can take months (and sometimes years) to materialize. That is why you will often hear economists describe currency as being a veil. A monetary policy can help to stimulate the economy in the short-term, but it has no long-term effects except for a general increase in pricing. The actual economic output which occurs does not receive the boost one would expect. The independent nature of the central banks allows for the monetary policy to be kept separate from legislative policy. That doesn’t mean the government won’t try to influence the decisions which are made using the tools that are available, but it does not give elected officials the opportunity to control them at a whim.

When economic activity slows or deteriorates, the government may try to improve it by reducing taxes or increasing its spending on various government programs. It involves spurring or slowing economic activity using taxes and government spending. Expansionary fiscal policy is usually characterized by deficit spending. Deficit spending occurs when government expenditures exceed receipts from taxes and other sources. In practice, deficit spending tends to result from a combination of tax cuts and higher spending.

What is the approximate value of your cash savings and other investments?

Consumers are encouraged to cut back on spending to slow down economic growth. As corporate profits fall, stock prices decline, and the economy goes into a period of contraction. Monetary policy and fiscal policy refer to the two most widely recognized tools used to influence a nation’s economic activity. Monetary policy is primarily concerned with the management of interest rates and the total supply of money in circulation and is generally carried out by central banks, such as the U.S. Fiscal policy is a collective term for the taxing and spending actions of governments.

The health of the economy overall is a complex equation, and no one factor acts alone to produce an obvious effect. However, when the government raises taxes, it’s usually with the intent or outcome of greater spending on infrastructure or social welfare programs. These changes can create advantages and disadvantages of fiscal policy more jobs, greater consumer security, and other large-scale effects that boost the economy in the long run. The government has two tools it uses when implementing fiscal policy. The first tool is collecting taxes on business and personal income, capital gains, property, and sales.