FISCAL POLICY

Fiscal policy is one concept strongly advocated by Keynes. After all, Keynesian economists are those who support government regulation. Fiscal policy, then, is government regulation of its own spending and taxes to influence a country's economy. Fiscal policy works as government spending and taxes can provide an initial shock to the economy that triggers adjustments. Increasing taxes, for example, would cut down on people's disposable income and slow the economy in an effort control it. On the other hand, lowering taxes can give people more money to spend and thus provide a boon to the economy. Increasing government spending, too, can give suppliers an incentive to increase production and thus increase income.

There are two types of fiscal policy, depending on what the goal is. Expansionary fiscal policy means an increase in overall spending in the economy is represented by an upward shift of the expenditures graph. On the other hand, contractionary fiscal policy is represented by a downward shift of the consumption graph. Using mathematical and graphical analysis, it's possible to predict the affects of government fiscal policy. As the graph of expenditures shifts up and down, we can find the point of intersection with the production graph to find the new equilibrium income.

There are certain problems associated with fiscal policy. Government policy is affected by its spending. When spending is greater than income, there is a deficit. When income is greater than spending, there is a surplus. The deficit/surplus affects income, and income is affected by it. When the government is running a deficit, it can not increase spending. Also, when a government must increase spending, a tax increase is sometimes in order as well, having the opposite affect on the economy. Besides the government deficit/surplus problem, there is the trade deficit/surplus problem. When people's income increases, they tend to import more, measured in MPM, marginal propensity to import. For example, if the MPM was .2 and income in the economy rose by 100 monetary units, then imports will increase by 20 monetary units. When there is too much importing, an economy risks running a trade deficit, which can have serious consequences for the economy. The trade balance is affected by and affects the income level. Fiscal policy making is about deciding what kind of policy is needed, dealing with government inefficiency (governments generally tend to act slowly in economics), and dealing with the government's own financial liabilities and debts. In general, fiscal policy helps to stabilize the economy so that the economy does not experience sharp and uncontrollable swings of expansion and recession. Fiscal policies slow both processes.