Course

Fiscal Policy

Instructor: Tyler Cowen, George Mason University

This is " Introduction to Fiscal Policy " from our Principles of Economics: Macroeconomics course. What is fiscal policy? Very simply, it’s a government’s policies

This is "Introduction to Fiscal Policy" from our Principles of Economics: Macroeconomics course.

What is fiscal policy? Very simply, it’s a government’s policies on taxes, spending, and borrowing. But how it’s practiced is a little more complicated. Fiscal policy can be used in an effort to mitigate fluctuations in the business cycle – to soften the effects of those booms and busts.

Let’s start by taking a look at expansionary fiscal policy – which leads to something called the “fiscal multiplier.” You see, when government increases spending for a new road during a recession, unemployed workers will be put to work. They’ll earn money, and they’ll start spending that money. The recipients of that spending will in turn spend more, and so on. That initial government spending multiplies.

Now consider an economy that’s operating at full employment (basically everyone that wants a job has one and physical capital is not idle). If the government were to increase spending under these circumstances for a project like a new road, what would happen? It would have to take away some of the resources being put to use in the private sector. The consequences for GDP in this case would be more or less neutral.

In contrast, governments can also practice contractionary fiscal policy. You can probably guess what these policies look like: increased taxes or decreased spending during a boom – or at least that’s the theory.

(Want to see a couple of economists debate fiscal policy? Check out our Econ Duel: Does Fiscal Policy Work?)

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