Fiscal Policy

Fiscal policy refers to taxing and spending policies of governments, often with a specific focus on budgeting and the effect of taxing and spending on the broader economy. Fiscal policy is one of, if not the, largest way in which governments affect economies.

Fiscal Policy Essentials

There is nothing inherent preventing state and local governments from running deficits in the same way that national governments do. However, almost all U.S. State constitutions have balanced budget amendments, which legally prevent those specific states from doing so.

Contractionary fiscal policy can decrease the crowding-out effect by increasing the amount of credit available to other borrowers because less lending is going to the government to finance its debt.

No, States cannot declare bankruptcy as it is not permitted by U.S. bankruptcy law. In addition, the U.S. Supreme Court decided in 1977 that Article 1, Section 10 of the U.S. forbids them from doing so.

Deficits are a critical tool in fiscal policy, allowing extra spending over and above what the government collects in taxes. This allows governments to finance important initiatives such as infrastructure improvement, economic stimulus during economic downturns, and national defense in wartime.

Key Terms

Fiscal Policy Subsidy Financial System Smoot-Hawley Tariff Act Implementation Lag Works Progress Administration (WPA)

Fiscal policy refers to how governments collect and spend money. Fiscal policy is critical to how the government affects the economy at large.

A subsidy is money given to an individual or organization by the government. Government subsidies are often given to businesses to try to bolster sectors of the economy considered especially important.

A financial system is a network of organizations that enable financial transactions. Financial systems are made up of, among other institutions, banks, insurance companies, and stock brokerages. While there is a global financial system, there are also many national and regional financial systems that interact with and overlap with each other and the world financial system.

The Smoot-Hawley Tariff Act, the colloquial name for the United States Tariff Act of 1930, raised U.S. tariffs on many goods by 20%. This tariff, passed after the onset of the Great Depression, provoked retaliatory tariffs from many other countries. This trade war likely resulted in economic damage, but the amount is disputed.

Implementation lag refers to the length of time between when an economic event, like a recession, begins, and when government interventions to deal with it are put in place. As such, governments need to try and take this lag into account or their interventions may be tailored to situations that are now passed.

The works progress administration was a fiscal stimulus program created in 1935 as part of the New Deal to combat the Great Depression. It sought to lower the unemployment rate by directly hiring people to do various kinds of work, such as building infrastructure projects.

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