Impact Of Government Policies On Economic Development – Fiscal policy refers to the use of government spending and tax policies to influence economic conditions, especially macroeconomic conditions. These include aggregate demand for goods and services, employment, inflation and economic growth.

During a recession, the government may lower tax rates or increase spending to stimulate demand and stimulate economic activity. Conversely, to combat inflation, it can raise rates or reduce spending to cool the economy.

Impact Of Government Policies On Economic Development

Fiscal policy is often contrasted with monetary policy, which is set by central bankers rather than elected government officials.

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US fiscal policy is largely based on the ideas of the British economist John Maynard Keynes (1883-1946). He argued that economic recessions are the result of a shortfall in the consumer spending and business investment components of aggregate demand.

According to Keynes, governments can stabilize the business cycle and regulate economic output by adjusting spending and tax policies to meet private sector shortfalls.

His theories were developed in response to the Great Depression, which rejected the assumption of classical economics that economic changes were self-correcting. Keynes’s ideas were influential and led to the New Deal in the US, which meant massive spending on public works projects and social welfare programs.

In Keynesian economics, aggregate demand or spending drives economic performance and growth. Aggregate demand consists of consumer spending, business investment spending, net government spending, and net exports.

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According to Keynesian economists, the private sector components of aggregate demand are too volatile and too dependent on psychological and emotional factors to maintain sustainable economic growth.

Pessimism, fear and uncertainty among consumers and businesses can lead to economic downturns and depressions. What’s more, in good times the excesses of the public sector can overheat the economy and inflation.

However, Keynesians believe that government taxes and spending can be rationally managed to counter excesses and deficits in private sector consumption and investment spending to stabilize the economy.

When private sector spending is reduced, the government can spend more and/or tax less to directly increase aggregate demand. When the private sector is too optimistic and spends too much, too quickly on consumption and new investment projects, the government can spend less and/or tax more to reduce aggregate demand.

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This means that to help stabilize the economy, the government should run large budget deficits during economic downturns and run budget surpluses when the economy is growing. These are known as expansionary or contractionary fiscal policies, respectively.

During the Great Depression of the 1930s, unemployment in the US rose to 25% and millions stood in bread lines for food. The misery seemed endless. President Franklin D. Roosevelt decided to implement an expansionary fiscal policy. Shortly after taking office he launched his New Deal. He created new government agencies, the WPA jobs program, and the Social Security program that exists today. These spending efforts, along with continued expansionary policies throughout World War II, pulled the country out of the Depression.

To illustrate how the government can use fiscal policy to influence the economy, consider an economy experiencing a recession. The government can provide tax stimulus allowances to increase aggregate demand and stimulate economic growth.

The logic behind this approach is that when people pay lower taxes, they have more money to spend or invest, which encourages higher demand. This demand leads companies to hire more, reducing unemployment and causing fierce competition for work. This serves to raise wages and give consumers more income to spend and invest. It is a virtuous cycle or positive feedback loop.

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Alternatively, instead of lowering taxes, the government can seek economic expansion by increasing spending (without a corresponding tax increase). Building more highways, for example, can increase employment, driving demand and growth.

Expansionary fiscal policy is usually deficit spending. Deficit spending occurs when government spending exceeds receipts from taxes and other sources. In practice, deficit spending usually results from a combination of tax cuts and higher spending.

Faced with rising inflation and other symptoms of expansion, a government may engage in contractionary fiscal policy, perhaps leading to a brief recession, to rebalance the business cycle.

While expansionary fiscal policy leads to spending deficits, contractionary fiscal policy leads to budget surpluses. This policy is rarely used, however, because it is not very popular politically.

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Public policies therefore have different incentives in terms of pursuing expansionary or contractionary fiscal policy. For this reason, the preferred tool to sustain sustainable growth is usually a contractionary monetary policy. Monetary policy involves the Federal Reserve raising interest rates and limiting the money supply and credit supply in order to contain inflation.

The two main fiscal policy tools used by the US government to influence the nation’s economic activity are tax rates and government spending.

Deficits are growing amid complaints against expansionary fiscal policy. Critics charge that the flood of government red ink could weigh on growth and eventually create the need for damaging austerity.

Many economists debate the effectiveness of expansionary fiscal policies. That government spending too easily overrides private sector investment.

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Expansionary policy is also popular—to a dangerous degree, say some economists. Reversing the fiscal stimulus is politically difficult. Regardless of the desired macroeconomic consequences, voters like low taxes and public spending.

Because of the political incentives faced by policymakers, there is often a consistent tendency to engage in more or less constant deficit spending, which can be rationalized to some extent as good for the economy.

Eventually, economic expansion can get out of hand. Rising wages lead to inflation and asset bubbles begin to form. High inflation and the risk of widespread defaults when debt bubbles burst can severely damage the economy. This risk in turn leads governments (or their central banks) to reverse course and try to shrink the economy.

Fiscal policy is the responsibility of the government. It involves the use of taxes and government spending to stimulate or slow down economic activity.

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Monetary policy is the domain of the US Federal Reserve Board and refers to actions taken to increase or decrease liquidity through the nation’s money supply. According to the Federal Reserve Board, these actions are “intended to promote maximum employment, stable prices, and moderate long-term interest rates, the economic goals that Congress has directed the Federal Reserve to pursue.”

The monetary policy tools that the Fed uses to increase or decrease liquidity (and to affect consumer spending and borrowing) are:

In the United States, fiscal policy is directed by the executive and legislative branches. In the executive branch, the two most influential positions in this regard are the President and the Secretary of the Treasury, although today’s presidents often rely on the Council of Economic Advisers as well.

In the legislative branch, the US Congress approves taxes, laws, and appropriations for any fiscal policy measure through the power of the purse. This process involves the participation, deliberation and approval of both the House of Representatives and the Senate.

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Fiscal policy instruments are used by governments to influence the economy. These mainly include changes in tax levels and government spending. To stimulate growth, taxes are lowered and spending is increased. This often involves borrowing by issuing public debt. To cool an overheated economy, taxes may be raised and spending reduced.

Often, the effects of fiscal policy are not felt equally by everyone. Depending on policymakers’ political orientations and goals, tax cuts may only affect the middle class, which is usually the largest economic group. In times of economic decline and tax increases, this group may have to pay more taxes than the wealthiest upper classes.

Likewise, when a government decides to adjust its spending, its policy can only affect a specific group of people. The decision to build a new bridge, for example, will provide jobs and additional income for hundreds of construction workers. A decision to spend money on building a new space shuttle, on the other hand, only benefits a small and specialized group of experts and businesses, which would do little to increase the aggregate level of employment.

One of the biggest hurdles policymakers face is deciding how much direct involvement government should have in the economy and people’s economic lives. In fact, in the history of the United States, the government has had various levels of interference. It is generally accepted that some form of government involvement is necessary to maintain a vibrant economy, on which the economic well-being of the population depends.

Government Intervention In The Economy

Fiscal policy is directed by the US government with the goal of maintaining a healthy economy. The tools used to stimulate beneficial economic activity are adjustments in tax rates and government spending.

When economic activity slows or worsens, the government can try to improve by cutting taxes or increasing spending on various government programs.

When the economy is too active and inflation threatens, it raises taxes or cuts spending. However, they are not liked by politicians who want to stay in office. Thus, in such cases, the government looks to the Fed to take monetary policy actions to reduce inflation.

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