Business & Finance Economics

How the Government Uses Fiscal Policy to Influence the Economy

The U.
economic environment has been a widely discussed topic over the last several years.
Signs of a recovery-albeit small-have surfaced providing many consumers hope that high levels of unemployment and low consumer spending are a thing of the past.
While the economic recovery remains in its infancy, it's important to understand how government attempts to influence the economy.
Although the effectiveness of various government attempts to stimulate the economy have been widely debated, the intended purpose of such programs is clear.
The U.
government has several tools at its disposal in its efforts to influence the overall health of the economy.
Those tools typically fall into two different categories: monetary policy and fiscal policy.
Although the intended purpose of these tools is similar, the means by which they influence the economy is quite different.
Monetary policy focuses on influencing the economy through manipulation of the money supply.
Through tools such as the fed funds rate, open market operations, and the discount rate, the Federal Reserve expands and contracts the money supply.
Fiscal policy, which is the topic of this article, involves the use of government taxation and spending to influence the economy.
The government will typically maintain low tax levels in times of economic instability in an attempt to promote spending.
When the government raises taxes it reduces the disposable income of households, which typically translates to less money for discretionary spending.
Let me provide an example to help explain how fiscal policy works.
In 2008 many economic indicators pointed to the likelihood that we were entering an economic recession.
In a last ditch effort to support the economy, the federal government passed the Economic Stimulus Act.
This provided a one-time payment of $600 to individual tax filers and $1,200 for joint filers.
It's important to note that the government didn't expand the money supply here; they merely redistributed money to those who would hopefully spend it.
Consumer spending is pivotal to our economic stability as two-thirds of the U.
gross domestic product is based upon consumer spending.
With additional funds available, the belief that predicated this government measure was that consumers would spend this surplus.
This would inject a significant amount of money into the economy.
Also important is that demand for goods and services would increase due to increased spending, which may force businesses to hire more workers to accommodate the uptick in demand.
A lower unemployment rate would translate to more consumers having greater discretionary income, which would translate into more spending.
Taxes must also be paid, which means more money for the various levels of government.
As you can see this process is cyclical in nature, and consumer spending is its primary driver.

You might also like on "Business & Finance"

Leave a reply