Fiscal policy is the method of government expenditure and tax collection to stimulate the economy and maintain growth. Using fiscal policy to shape consumer spending and business development has its advantages and disadvantages. When a government employs smart fiscal policy, consumers have more money to spend and businesses can find capital to grow more easily. When a government uses fiscal policy irresponsibly, the cost of goods and services can balloon out of control.
Stimulating the Economy
Economists in the Keynesian school believe fiscal policy is a potent tool for stimulating growth in an economy which is operating well below acceptable levels. A government may use fiscal policy to boost the level of aggregate demand in the economy. Aggregate demand is the total demand for all goods and services across a given nation. A government increases this demand in several ways, including cutting personal income tax to create more disposable income or cutting indirect taxes that leads to lower prices for goods and services.
Controlling Inflation Rates
Fiscal policy is useful in helping to fight inflation rates in an economy. Inflation is the rise in the price of goods and services absent of an increase in money in the economy. As a result, consumers must pay more for goods and services with less available cash. A government or its agencies may attempt to fight inflation by using fiscal policy to control the rate at which prices increase. One major method of fighting inflation is through the release of more funds in the economy. A government may accomplish this through purchasing government securities, including bonds, from the market to increase cash flow.
Slow Reaction Times
Fiscal policy can be slow to react to economic conditions. This is because the setting of fiscal policy in a government often involves multiple decision-making bodies with different political agendas and schools of economic thought. The debate this convergence of opinion causes slows down a government's response to a potential economic crisis, which allows the problem to worsen. The delay in action may also blunt a government's effort to control economic problems because fiscal policy actions take longer to show positive economic change.
Economists and government officials ultimately guess at what will happen in an economy over the course of time and set fiscal policy to match those assumptions. Sometimes they just get it wrong. False assumptions or incorrect fiscal projections can mean a government's fiscal policy actually hurts the economy instead of helping it maintain steady growth. This was seen in 2008 when the United Government issued economic stimulus checks to the majority of its citizens. The majority of Americans used this stimulus to pay existing debts instead of putting into circulation by purchasing goods and services. The end result was a blunted economic stimulus.