What Exactly Is Financial Management?
 

The use of government spending and tax policies, as well as other fiscal policies, to impact economic conditions, particularly macroeconomic factors, is referred to as fiscal policy. These factors include the overall demand for goods and services, employment levels, overall price levels, and overall economic growth.

In times of economic slowdown, the government may choose to cut tax rates or boost spending in order to stimulate consumer spending and overall economic activity. On the other hand, in order to fight inflation, the government can raise interest rates or reduce spending in order to slow down the economy.

The term "fiscal policy" is frequently contrasted with "monetary policy," the latter of which is implemented by central bankers rather than by elected officials of the government.

KEY TAKEAWAYS
 

• The practise of influencing economic conditions through changes in government spending and tax policies is referred to as fiscal policy.
   
• John Maynard Keynes, a British economist, was a significant contributor to the formulation of modern fiscal policy.
   
• Instead of allowing markets to correct themselves on their own, Keynes proposed that governments should intervene in the economy to control economic production and the business cycle.
   
• In order to stimulate economic expansion and boost aggregate demand, expansionary fiscal policy entails either a reduction in the tax burden or an increase in government spending.
   
• In order to prevent or lower inflation, a contractionary fiscal policy will either raise interest rates or slash spending.
   

Understanding Fiscal Policy
 

The views of the British economist John Maynard Keynes (1883-1946) play a significant role in the formation of U.S. fiscal policy. He maintained that economic recessions are caused by a lack of aggregate demand, specifically in the areas of consumer spending and company investment.

Keynes argued that governments might stabilise the business cycle and regulate economic output by modifying spending and tax policies to make up for the deficits of the private sector. This was one of Keynes' major contributions to the field of economics.
 

The Great Depression challenged the assumptions of classical economics, which held that cyclical ups and downs in the economy were self-correcting. In response, he developed his ideas to explain this discrepancy. The theories of Keynes had a significant impact and were a contributing factor in the development of the New Deal in the United States. This policy called for enormous investments to be made in public works projects and social welfare programmes.

According to the principles of Keynesian economics, the performance and expansion of the economy are both determined by aggregate demand, also known as spending. Spending by consumers, investment spending by businesses, net spending by governments, and net exports are the components that make up aggregate demand.

Behavior that varies across the private sector
 

Economists who subscribe to the Keynesian school of thought believe that the private sector components of aggregate demand are not stable enough and depend too heavily on psychological and emotional variables for the economy to experience continuous growth.
 

Fear, pessimism, and uncertainty on the part of both customers and business owners can contribute to economic slowdowns and even depressions. In addition to this, excessive public sector exuberance during times of economic expansion can result in an economy that is overheated and inflation.

However, Keynesians think that taxation and spending by the government can be handled sensibly and utilised to offset the excesses and inadequacies of private sector consumption and investment spending in order to stabilise the economy. In other words, Keynesians believe that government spending and taxation can be managed to stabilise the economy.
 

Actions in the Public Budget That Are Corrective
 

When there is less spending in the private sector, the government has the ability to raise expenditure and/or lower taxes in order to directly boost aggregate demand. When the private sector is unduly enthusiastic and spends too much, too quickly on consumption and new investment projects, the government can spend less and/or tax more in order to decrease aggregate demand. This is especially effective when the private sector is overly optimistic.

This indicates that the government ought to run big budget deficits during times of economic contraction in order to assist in the stabilisation of the economy, and ought to run budget surpluses during times of economic expansion. The former is referred to as expansionary fiscal policy, whereas the latter is known as contractionary fiscal policy.  

Different Categories of Fiscal Policies

Policies and Methods That Encourage Growth
 

Consider the case of a country that is going through a recession to better understand how the government can influence the economy through the employment of fiscal policy. In order to boost aggregate demand and encourage economic expansion, the government can decide to offer tax rebates as part of a stimulus package.

This strategy is based on the idea that if individuals pay lower tax rates, they will have more money available to spend or invest, which will in turn stimulate higher levels of demand. Because of this demand, businesses are hiring more people, which brings the unemployment rate down but also creates intense competition for jobs. This, in turn, helps to improve salaries and provides customers with more income, which gives them more room to spend and invest their money. This can be thought of as a positive feedback loop or virtuous cycle.

[1/5]What lessons have we learnt for fiscal policy through the pandemic and after? On the plus side, contrary to the view that fiscal policy is a slow boat to steer, we learnt that fiscal policy can be quick and innovative, at least during a major crisis. https://t.co/hiA7G2kqTv pic.twitter.com/oGEzriynF2

— Gita Gopinath (@GitaGopinath) June 2, 2023

Alternately, rather than reducing tax rates, the government can strive to expand the economy by raising spending (without concurrent increases in tax rates). The construction of additional motorways, for instance, may lead to an increase in employment, which would in turn boost demand and growth.

The typical hallmark of an expansionary fiscal strategy is the incurring of deficits through spending. When a government's expenditures are higher than the revenue it receives from taxes and other sources, this results in deficit spending. In actuality, the most common cause of budget deficits is the concurrent enactment of tax reductions and increases in spending.

Policies and Methods That Are Constructionist in Nature
 

Contractionary fiscal policy can be pursued by a government in the face of rising inflation and other expansionary signs, possibly even to the point of producing a brief recession in order to restore equilibrium to the business cycle. This is done in order to bring the economy back into equilibrium.

The government accomplishes this goal through raising taxes, decreasing public spending, and slashing wages and positions in the public sector.

A contractionary fiscal policy is characterised by budget surpluses, in contrast to an expansionary fiscal policy, which is characterised by spending deficits. However, due to the fact that it is so politically controversial, this strategy is not implemented very often.

When deciding whether to implement expansionary or contractionary fiscal policy, public policymakers are therefore confronted with a variety of competing incentives. Therefore, a contractionary monetary policy is typically considered to be the most effective instrument for bringing under control unsustainable growth. In order to bring inflation under control, the Federal Reserve would likely raise interest rates and restrict the availability of both money and credit. This is an example of monetary policy.

Tax rates and government expenditures are the two primary weapons of fiscal policy that the federal government of the United States employs to exert control over the economic activities of the nation.

Consequences of Having an Expanding Policy
 

One of the primary criticisms levelled against expansionary fiscal policy is the widening of existing deficits. Critics argue that an onslaught of red ink from the government can stifle economic expansion and, in the long run, make it necessary to impose severe austerity measures.

There is widespread disagreement among economists over the efficiency of expansionary fiscal policies. They contend that private sector investment can be easily pushed out of the market by excessive government spending.

Some economists believe that the prevalence of expansionary policies has reached an unsustainable level. Reversing the effects of fiscal stimulus is challenging from a political standpoint. Voters prefer low taxes and increased public spending, regardless of whether or not it has the desired consequences on the macroeconomy.

As a result of the political pressures that are placed on policymakers, there is a persistent tendency for them to have a predisposition towards participating in more or less constant deficit spending, which can be partially rationalised as being beneficial for the economy.

Related link : Investors are Keeping an Eye on Bearish Inflation News Despite the Debt Ceiling Debate That Is Still Going On

The expansion of the economy has the potential to spiral out of control at some point. Increasing wages cause inflation, which then leads to the formation of asset bubbles. A severe blow to the economy could be dealt by persistently high inflation as well as the possibility of widespread defaults in the event that debt bubbles burst. This danger, in turn, causes governments (or their central banks) to try to reverse course and restrict the economy in an effort to mitigate the risk.
Comparing Monetary Policy and Fiscal Policy
The government is in charge of formulating and implementing fiscal policy. It entails utilising taxation and government spending as tools to either stimulate or dampen economic growth.

The Federal Reserve Board is in charge of monetary policy in the United States, which is the term used to describe the measures that are made to either boost or decrease liquidity through a country's money supply. The Federal Reserve Board states that the purpose of these activities is to "promote maximum employment, stable prices, and moderate long-term interest rates," which are the economic goals that Congress has authorised the Federal Reserve to pursue.
 

The Federal Reserve employs the following instruments of monetary policy in order to boost or decrease liquidity (and hence influence consumer spending and borrowing):

• Purchasing or selling investments in an unregulated market.
   
• By way of its discount window, making loans to deposit taking institutions
   
• Altering the discount rate by either increasing or decreasing it
   
• Altering the federal funds rate by either raising or reducing it
   
• putting in place minimum reserve requirements for financial institutions
   
• Taking part in liquidity swaps with the central bank
   
• overnight repurchase agreements as a means of providing financing
   

Who Is in Charge of the Fiscal Policy?
 

Both the executive branch and the legislative branch in the United States are responsible for directing the country's budgetary policy. Even though modern presidents frequently rely on a Council of Economic Advisers as well, the President and the Secretary of the Treasury hold the two offices in the executive branch that have the most sway in this respect. These offices are the most influential in this regard.

The power of the purse is exercised by the United States Congress, which is part of the legislative branch of the United States government, to authorise taxes, make legislation, and appropriate spending for any and all fiscal policy actions. Both the House of Representatives and the Senate need to be involved in this process in order for it to be considered, deliberated upon, and approved.

What Are the Primary Instruments That Are Used in Fiscal Policy?
 

The tools of fiscal policy are the means by which governments exert their influence over the economy. These mostly include alterations to the current levels of taxation and spending by the government. Tax rates are reduced, and government expenditure is ratcheted up, in an effort to kickstart economic expansion. This frequently requires taking on debt in the form of government loans. Taxes could be raised and spending cut in order to bring down the temperature of an overheating economy.

In what ways do people get affected by fiscal policy?
 

The impacts of monetary and fiscal policy do not always have the same impact on each and every person. It's possible that a tax cut will just benefit the middle class, even though that's normally the greatest economic group there is. This will depend on the policymakers' political leanings and their intentions. It is possible that this particular group will be required to pay higher taxes than the upper middle class and upper class in times of economic downturn and rising taxation.

In a similar vein, when a government chooses to change its spending, the policy that it implements may only have an impact on a particular subset of the population. For instance, the decision to construct a new bridge will provide hundreds of construction workers with employment opportunities, which will in turn increase their incomes. Spending money on the construction of a new space shuttle, on the other hand, would only help a select group of highly specialised professionals and businesses, which would not contribute much to an overall increase in employment levels.

Should There Be a Greater Role for the Government in the Business World?
 

The decision of how much direct engagement the government ought to have in the economic life of individuals and the economy as a whole is one of the most difficult challenges that policymakers are faced with. In point of fact, throughout the course of the history of the United States, there have been varying degrees of meddling on the part of the government. It is generally acknowledged that some level of intervention on the part of the government is required in order to maintain a thriving economy, which is essential to the economic well-being of the people as a whole.

The Crux of the Matter
 

The mission of the United States government's fiscal policy is to ensure the continued prosperity of the nation's economy. Alterations to tax rates and changes in spending by the government are the tools that are utilised to promote economically beneficial activity.

When there is a decline in economic activity or when it is already occurring, the government may try to stimulate the economy by lowering taxes or by raising spending on a variety of government programmes.

If the economy is growing too quickly and there is a risk of inflation, the government might choose to raise taxes or cut spending. However, neither of these options is appealing to politicians who are interested in maintaining their positions. Therefore, in situations like these, the government looks to the Fed to take action on monetary policy in order to bring inflation down.