Fiscal policy shall be discussed on this paper largely based on two sources: David N. Weil’s (2002) “Fiscal Policy” article from the Concise Encyclopedia of Economics; and Sparknotes’ (2006) discussion on “Fiscal Policy. ” As such, this paper shall be divided into the following parts: What fiscal policy is; types of fiscal policy; fiscal policy as a tool for economic stabilization; what fiscal policy affects. What Fiscal Policy Is According to Weil, fiscal policy refers to the “use of government budget to affect an economy.
” By “use,” we generally refer to two actions, namely taxation and government spending. In the imposition of taxes, the government “receives revenue from the populace” (Sparknotes), that is, there occurs a transfer of funds or assets from the people to the government. Government spending, on the other hand, does the reverse: assets this time are transferred from the government to the people in the form government wages, social security, health services, and many others.
Through taxation and government spending then, the economy is “affected. ” At this point, the equation for output or national income comes in very helpful. In the equation Y=C(y-T) + I + G + NX, (1) Y is output or national income, y-T is disposable income (represented by the equation, income minus taxes), C is consumption spending, I is investment, G is government spending, and NX is net exports.
From this equation, we see both taxes (i. e. , T) and government spending (i. e. , G) in the picture and hence we could safely say that these two fiscal policy actions can and do affect national income or output, and as such, affect the economy. How these two actions concretely affect the economy shall be discussed in the next section. Types of Fiscal Policy There are two types of fiscal policy measures: expansionary and contractionary fiscal policy. An expansionary fiscal policy measure increases the “amount of money available to the populace” (Sparknotes). This type of measure ideally increases output or national income.
This increase in output happens when taxes are lowered and/or government spending is increased. If we look at equation (1) again, we should notice that both increase in government spending (G) and a decrease in taxation (T) [assuming stable income y and thus an increase in consumption spending C] increase output (Y). In either or both instances of increased government spending or decreased taxation, the amount of available money to the population is increased, and as such, the populace is assumed to be wealthier and the output or national income is likewise increased.