What is Fiscal Policy?

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Fiscal policy simply is using the federal government’s ability to tax and spend to influence the economy.

Government generates revenue for itself by taxing its citizens and corporations, generating seigniorage from making coins, borrowing, using its reserves (we have none BTW), and selling its assets.  And government spends the revenue on paying off the debt and interest from borrowing money, on spending mandated by law like Social Security, Medicare, and Medicaid, and on discretionary spending like for government itself, social programs, and defense.

When the federal government spends more than it takes in, it is called expansionary fiscal policy and is usually meant to stimulate economic growth.  The difference is called the federal deficit.  When the federal government spends less than it takes in, it is called contractionary fiscal policy and is usually meant to slow economic growth.  That difference is called the federal surplus.  When the government spends exactly what it takes in, then it is called a balanced budget.

All the federal deficits and surpluses accumulated are called the federal debt.  Congress (who passes the law) and the Presidents (who signs the law) determine the federal debt ceiling, which is how high the debt goes before the government prohibits itself from borrowing more money.

In 2012, the federal government took in $2.5 trillion and spent $3.5 trillion, and had to borrow $1 trillion to fund the difference.  The federal debt ceiling was $16.4 trillion, which our total accumulated deficits reached the debt ceiling in May 2013.  Without the authority to borrow more money, the Treasury department is using extraordinary cash management to stretch out cash, postponing the day of reckoning until late summer or early fall.

How do we make sense of these big numbers?  Picture the federal government as a person in 2012 making $25,000 a year, spending $35,000 a year, and adding $10,000 a year to credit card debt.  The credit card has a $164,000 limit, which has been reached, and the annual interest payment is $2,600.  And in 2013, this person wants to spend $38,000 and is negotiating to have the credit card limit raised or trying to get a bank to loan them the difference.

Fiscal policy is more important than monetary policy because the President and Congress, who are elected by the people and expected to lead, determine it.  Further, good fiscal policy leads to robust economic growth, especially when supported by complimentary monetary policy.  But when fiscal policy is in shambles, monetary policy is not impactful enough to lead to robust economic growth.

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