In economics, fiscal policy is the use of government expenditure and revenue collection (taxation) to influence the economy.

[1] Fiscal policy can be contrasted with the other main type of macroeconomic policy, monetary policy, which attempts to stabilize the economy by controlling interest rates and the money supply. The two main instruments of fiscal policy are government expenditure and taxation. Changes in the level and composition of taxation and government spending can impact on the following variables in the economy:

Aggregate demand and the level of economic activity; The pattern of resource allocation; The distribution of income.

Fiscal policy refers to the use of the government budget to influence the first of these: economic activity.
[edit]Stances

of fiscal policy

The three possible stances of fiscal policy are neutral, expansionary and contractionary. The simplest definitions of these stances are as follows:

A neutral stance of fiscal policy implies a balanced economy. This results in a large tax revenue. Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity. An expansionary stance of fiscal policy involves government spending exceeding tax revenue. A contractionary fiscal policy occurs when government spending is lower than tax revenue.

However, these definitions can be misleading because, even with no changes in spending or tax laws at all, cyclical fluctuations of the economy cause cyclical fluctuations of tax revenues and of some types of government spending, altering the deficit situation; these are not

considered to be policy changes. Therefore, for purposes of the above definitions, "government spending" and "tax revenue" are normally replaced by "cyclically adjusted government spending" and "cyclically adjusted tax revenue". Thus, for example, a government budget that is balanced over the course of the business cycle is considered to represent a neutral fiscal policy stance.
[edit]Methods

of funding

Governments spend money on a wide variety of things, from the military and police to services like education and healthcare, as well as transfer payments such as welfare benefits. This expenditure can be funded in a number of different ways:

Taxation Seigniorage, the benefit from printing money Borrowing money from the population or from abroad Consumption of fiscal reserves. Sale of fixed assets (e.g., land).

All of these except taxation are forms of deficit financing

A fiscal deficit is often funded by issuing bonds, like treasury bills or consols and gilt-edged securities. These pay interest, either for a fixed period or indefinitely. If the interest and capital repayments are too large, a nation may default on its debts, usually to foreign creditors.
[edit]Consuming

prior surpluses

A fiscal surplus is often saved for future use, and may be invested in local (same currency) financial instruments, until needed. When income from taxation or other sources falls, as during an economic slump, reserves allow spending to continue at the same rate, without incurring additional debt.
[edit]Economic

effects of fiscal policy

Governments use fiscal policy to influence the level of aggregate demand in the economy, in an effort to achieve economic objectives of price stability, full employment, and economic growth. Keynesian

economics suggests that increasing government spending and decreasing tax rates are the best ways to stimulate aggregate demand. This can be used in times of recession or low economic activity as an essential tool for building the framework for strong economic growth and working towards full employment. In theory, the resulting deficits would be paid for by an expanded economy during the boom that would follow; this was the reasoning behind the New Deal. Governments can use a budget surplus to do two things: to slow the pace of strong economic growth, and to stabilize prices when inflation is too high. Keynesian theory posits that removing spending from the economy will reduce levels of aggregate demand and contract the economy, thus stabilizing prices. Economists debate the effectiveness of fiscal stimulus. The argument mostly centers on crowding out, a phenomenon where government borrowing leads to higher interest rates that offset the stimulative impact of spending. When the government runs a budget deficit, funds will need to come from public borrowing (the issue of government bonds), overseas borrowing, or monetizing the debt. When governments fund a deficit with the issuing of government bonds, interest rates can increase across the market, because government borrowing creates higher demand for credit in the financial markets. This causes a lower aggregate demand for goods and services, contrary to the objective of a fiscal stimulus. Neoclassical economists generally emphasize crowding out while Keynesians argue that fiscal policy can still be effective especially in a liquidity trap where, they argue, crowding out is minimal. Some classical and neoclassical economists argue that crowding out completely negates any fiscal stimulus; this is known as the Treasury View[citation needed], which Keynesian economics rejects. The Treasury View refers to the theoretical positions of classical economists in the British Treasury, who opposed Keynes' call in the 1930s for fiscal stimulus. The same general argument has been repeated by some neoclassical economists up to the present. In the classical view, the expansionary fiscal policy also decreases net exports, which has a mitigating effect on national output and income.

When government borrowing increases interest rates it attracts foreign capital from foreign investors. This is because, all other things being equal, the bonds issued from a country executing expansionary fiscal policy now offer a higher rate of return. In other words, companies wanting to finance projects must compete with their government for capital so they offer higher rates of return. To purchase bonds originating from a certain country, foreign investors must obtain that country's currency. Therefore, when foreign capital flows into the country undergoing fiscal expansion, demand for that country's currency increases. The increased demand causes that country's currency to appreciate. Once the currency appreciates, goods originating from that country now cost more to foreigners than they did before and foreign goods now cost less than they did before. Consequently, exports decrease and imports increase.[2] Other possible problems with fiscal stimulus include the time lag between the implementation of the policy and detectable effects in the economy, and inflationary effects driven by increased demand. In theory, fiscal stimulus does not cause inflation when it uses resources that would have otherwise been idle. For instance, if a fiscal stimulus employs a worker who otherwise would have been unemployed, there is no inflationary effect; however, if the stimulus employs a worker who otherwise would have had a job, the stimulus is increasing labor demand while labor supply remains fixed, leading to wage inflation and therefore price inflation.
[edit]Fiscal

Straitjacket

The concept of a fiscal straitjacket is a general economic principle that suggests strict constraints on government spending and public sector borrowing, to limit or regulate the budget deficit over a time period. The term probably originated from the definition of straitjacket: anything that severely confines, constricts, or hinders.[3] Various states in the United States have various forms of self-imposed fiscal straitjackets.
[edit]

International Central banks monetary conversion system

Tools of Fiscal and Monetary Policy

(Flow of currency) = (monetary mass) * (velocity of circulation of money) (Flow of goods and services) = (Prices index) * (Production SOLD) This equation may be of interest in an open economy if fiscal measures are taken, such as variable VAT, to make domestic production more competitive. Without such fiscal measures, all your monetary or budgetary strategies will benefit a more competitive foreign country, just as the United States budgetary policy now benefits more to Chinese than to US firms and workers. A. If the flow of currency is increasing (too much money or too much velocity of circulation), and if at the same time there is the same flow of goods and services, then the average price of goods and services will rise: it's inflation.

To curb inflation, the possibilities are: 1. to decrease the monetary mass: by monetary destruction or by higher rates (it is Mr. Greenspan's apparent strategy to curb inflation, a major goal of the monetary authority ) 2. to decrease the velocity of circulation of money: by immobilizing large amounts of money: it is Mr. Greenspan's real strategy to curb inflation by immobilizing hundreds of billions dollars in Asiatic central banks:

Bank of reserves Billions dollars

Japan in of

(Note that Asiatic countries benefit this strategy because inflation in the US would make dollar weaker and US firms more competitive: As a consequence, Asiatic exportations in the US would decrease, making their economy grow slowly... That's the reason why Asiatic countries support this policy by buying huge amounts of T-bonds with their dollars, until their economy and production process become stronger than the American ones). 3. to increase the Production sold: a) if there is too few Goods and Services available, one should increasing production, importations, and research to create new innovative products; b) if there is enough Goods and Services available one should give or lend money to the people who lack (welfare state) to stimulate the economy.

B. If the flow of currency is decreasing (lack of money or lack of velocity of circulation), and if at the same time there is the same flow of goods and services, then the average price of goods and services will decrease: it's deflation. To curb deflation, the possibilities are: 1. to increase the monetary mass: by monetary creation (simple creation, special bounds creation, creation guaranteed by gold, foreign currencies reserves or domestic assets, ...) or by debt and ordinary bounds emission.

2. to increase the velocity of circulation of money: by exceptional fiscal measures, each during 2 or 3 months, to induce people into spending their money 3. to decrease the production sold: in taxing unnecessary goods or services, taxing unnecessary importations, regulating lending, ...

The more comfortable situation is at the same time a growth in the flow of currency and of the production sold. Then prices remain stable:

These are basic monetary rules. Let's talk about key public monetary choices:

Usually, sold production increases since the society develops. Therefore, if the flow of currency does not increase, there is a risk of deflation. To curb that risk, as we explained, the state can decrease the production sold, but it is unpopular and abnormal, as society should constantly expands. It is also possible to increase the velocity of circulation of money, but there is a limit. The efficient solution is to increase the monetary mass: not too much (inflation risk), but enough to allow a regular increase in sold production (higher living standards) The crucial choice is: should the state increase the monetary mass by creation of money or by debt ??? Of course, it is better for the state to create its own money (it's easy, it's just paper), but banks prefer creating the money (it's easy, just paper), and lending it to the state. So it depends on the relative strength between public authorities and private banking. Note that the vast majority of countries use only debt for decades... For example, the huge American deficit with Asiatic countries means China, Japan, India, ... actually lend hundreds of billions dollars to the US government for the war in Iraq. Yet, even a strong state should not always create its own money: it's too easy and will hide poor productivity, old production process. A quick growth in monetary mass with no attention paid to the quality and productivity of domestic firms is inefficient. And speculators will use the international monetary exchange to attack this currency.

In my opinion, a better way to proceed is to create money to help financing recurrent social expenses (welfare) and reliable public infrastructures. Other economic investments should be financed by public or private lending, with rates 1 or 2 percentage points above inflation rise, so as to make sure they are not wasted money, but generate enough productivity and profit to refund loans. Here is the tree of life of a firm, a social organization, ... Organizing a firm like that should improve productivity.