What Is Fiscal Policy?
| Author | Mark Horton; Asmaa El-Ganainy |
| Position | Division Chief; Economist in the IMF’s Fiscal Affairs Department |
| Pages | 52-53 |
Page 52
FISCAL policy is the use of government spending and taxation to influence the economy. Governments typically use fiscal policy to promote strong and sustainable growth and reduce poverty. The role and objectives of fiscal policy have gained prominence in the current crisis as governments have stepped in to support financial systems, jump-start growth, and mitigate the impact of the crisis on vulnerable groups. In the communiqué following their London summit in April, leaders of the Group of Twenty industrial and emerging market countries stated that they are undertaking “unprecedented and concerted fiscal expansion.” What do they mean by fiscal expansion? And, more generally, how can fiscal tools provide a boost to the world economy?
Historically, the prominence of fiscal policy as a policy tool has waxed and waned. Before 1930, an approach of limited government, or laissez-faire, prevailed. With the stock market crash and the Great Depression, policymakers pushed for governments to play a more proactive role. More recently, countries scaled back the size and function of government, with markets taking on an enhanced role in the allocation of goods and services. Now, with the financial crisis in full swing, a more active fiscal policy is back in favor.
When policymakers seek to influence the economy, they have two main tools at their disposal—monetary policy and fiscal policy. Central banks indirectly target activity by influencing the money supply through adjustments to interest rates, bank reserve requirements, and the sale of government securities and foreign exchange; governments influence the economy by changing the level and types of taxes, the extent and composition of spending, and the degree and form of borrowing.
Governments directly and indirectly influence the way resources are used in the economy. The basic equation of national income accounting helps show how this happens:
GDP = C + I + G + NX.
On the left side is gross domestic product (GDP)—the value of all final goods and services produced in the economy (see “Back to Basics,” F&D, December 2008). On the right side are the sources of aggregate spending or demand—private consumption (C), private investment (I), purchases of goods and services by the government (G), and exports minus imports (net exports, NX). This equation makes it evident that governments affect economic activity (GDP), controlling G directly and influencing C, I, and NX indirectly...
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