Wednesday, April 29, 2015

What is fiscal policy

If I were to guess, I'd suggest that when most people hear the words fiscal policy, they would think of the government's taxing, spending, and borrowing. In economics, the words have a broader meaning. Upon reflection, I would say that fiscal policies are the choices that the government collectively makes with regard to the use of purchasing power and the means by which such purchasing power is obtained. When putting this definition together, I had in my mind the need to encompass the following: purchases of goods and services, employment and retirement of government workers, transfer policies, taxes, fees, intergovernmental transfers, borrowing, and helicopter money.


The uses of puchasing power are fairly straightforward. The two main categories are transfer payments and providing goods or services. Transfer payments are simply distribution of purchasing power to a set of individuals. The best known policy of this nature is social security, which distributes money to the disabled and senior citizens. Providing goods and services involve a combination of buying goods and services from businesses and employing government workers (which also means providing for their retirement).


There are fundamentally two ways to pay for the government's use of purchasing power: taxation and printing money. The primary way is through taxation (whether through "taxes" or "fees").

A major issue in finance is when this taxation will occur. The typical "balanced budget" approach is for the government to pay for all expenditures in a period by raising an equal amount of revenue in the same period. The alternative "deficit/debt financing" approach is for the government to borrow in the current period and promise to repay lenders in the future. This latter option can employ loans or a bond, but the principle is the same (I'm ignoring the possibility of printing money, for simplicity and because nobody seriously suggests that as a sustained source of revenue).

There are two main ideas of how to conduct fiscal policies in the long run. One is to maintain a given level of nominal debt (i.e., revenues and expenditures are equal), the other is generally to maintain a stable debt-to-gdp ratio (nominal debt grows only as fast as nominal output). Think of it this way: policy may be aiming at lowering (for instance) nominal debt or the debt-to-gdp level, but there is generally a level that is going to be targeted in the long-run (even if that level is zero).

According to old keynesian and neowicksellian/new keynesian models, fiscal policy can stimulate an economy with less than full employment of productive factors (labor and capital).

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