What is Fiscal Policy?

Lesson Transcript
Instructor: Jason Nowaczyk

Jason has a masters of education in educational psychology and a BA in history and a BA in philosophy. He's taught high school and middle school

Fiscal policy is a mechanism used by the U.S government to control the economy by raising taxes or choosing how to spend money on investments. Learn more about the meaning, usage and criticisms of U.S fiscal policy. Updated: 10/06/2021

Fiscal Policy Defined

Imagine for a moment that the U.S. economy is like a roller coaster. It has that slow climb up that gets you nervous and wondering if you're going to make it to the top okay, yet you also feel excited because you get to see a breathtaking view once you reach the top of that first hill. The problem is once you reach the top of that hill, you realize that that pit in your stomach is back as you proceed to plummet down the other side of the hill.

While riding a roller coaster is fun in small doses, if the economy operated in a similar fashion for any extended period of time, it would wreak havoc on our society. I'm sure we can all agree that if the economy was a roller coaster, we would want the number of big drops to be as little as possible. Luckily, our government feels the same way, and to smooth out the ups and downs of our national economy, the government has several policy options.

One such option is known as the government's fiscal policy. Fiscal policy is the federal government's use of taxation and spending policies to affect overall business activity.

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  • 0:02 Fiscal Policy Defined
  • 0:57 Uses of Fiscal Policy
  • 2:24 Evaluating Fiscal Policy
  • 3:44 Lesson Summary
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Uses of Fiscal Policy

In regards to taxation and spending policies, the U.S. government can use fiscal policy in two ways:

  • Through raising or lowering taxes
  • Choosing how much money to spend

Both of these fiscal policy approaches take the economic burden off citizens and, depending on the economic situation, the government may want to do one or the other or a mixture of both.

In times of expansionary fiscal spending, when the government wants to increase demand for goods and get the economy out of a recession, the government will likely increase spending and/or cut taxes. Spending more and lowering taxes makes it more likely that consumers will spend more money themselves because they have more disposable income. However, this type of use increases the budget deficit, or when the government spends more money than it takes in because tax revenue is lower.

In times of deflationary fiscal spending, when the government wants to decrease overall demand for goods to prevent a boom and bust scenario, the government will likely cut government spending and/or increase taxes. Having to shoulder more of the economic burden because the government isn't spending any of their revenue while also having to pay more in taxes, citizens will reduce their spending because they don't have as much money. This type of policy, however, does help the government because it allows itself to keep more of its own money, and it also generates more revenue through higher taxes.

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