Economics “Ask the Instructor” Clip 66 Transcript
What is fiscal policy, and what is it supposed to accomplish?
Fiscal policy refers to intentional changes in federal government expenditures or in tax receipts
intended to smooth out the business cycle. Expenditures are increased to fight a recession and are reduced,
at least in theory, to combat demand-pull inflation. The other aspect of fiscal policy is taxes. Tax
collections are cut to fight a recession and are increased, again in theory, to combat demand-pull inflation.
The actual use of fiscal policy to stabilize the economy presents several problems. First, there is
the problem of timing. A recession may have been underway for several months before it is recognized.
Several months may elapse while Congress debates what action, if any, to take. Finally, it takes time for a
tax change to impact our wallets. In the case of a change in government spending, it takes time for
increased or reduced spending on government projects to “come online.” A second problem relates to what
is called crowding out. This refers to the chance that an increase in government spending will discourage
private-sector spending. If an increase in government spending is financed by borrowing and if that
borrowing raises market interest rates, there would likely be a decrease in private spending. To the extent
that crowding out occurs, fiscal policy will be less effective in stimulating aggregate demand.
Fiscal policy received a lot of attention during the Kennedy and Reagan presidencies, but it has played
second fiddle to monetary policy in recent decades. However, the election of George W. Bush in 2000 and
the economic slowdown of 2001 brought renewed attention to fiscal policy.