What Are the Goals of Fiscal Policy?

Fiscal policy is a government’s approach to influencing the economy through its spending and taxation decisions. It manages broad economic conditions like demand for goods and services, employment levels, inflation, and economic growth. Governments adjust these to guide the economy toward desired outcomes.

Core Objectives of Fiscal Policy

Fiscal policy aims for a stable, prosperous economy by achieving several macroeconomic objectives. One goal is promoting sustainable economic growth. This increases a country’s capacity to produce goods and services, leading to higher living standards. Economic growth is measured by Gross Domestic Product (GDP), representing the total value of goods and services produced within an economy.

Another objective is achieving full employment. This minimizes unemployment, ensuring jobs for those willing and able to work. High unemployment reduces economic output and increases social challenges, making full employment a desirable state.

Maintaining price stability involves controlling inflation and avoiding deflation. Inflation refers to a sustained increase in the general price level, eroding purchasing power. Deflation is a sustained decrease in prices, which can discourage spending and investment. Both extremes negatively impact an economy, making stable prices a target. Fiscal policy aims to keep inflation within a healthy range, often 2%–3% annually.

Fiscal policy can also address wealth and income disparities. Governments use fiscal measures to reduce inequality by redistributing resources for a more equitable society.

Key Tools of Fiscal Policy

Fiscal policy uses two primary tools: government spending and taxation. These tools adjust to stimulate or cool economic activity based on conditions.

Government spending allocates public funds across economic sectors. This includes infrastructure investments (e.g., roads, bridges) that create jobs and facilitate commerce. Spending also covers social programs, defense, education, and research, directly injecting money into the economy and influencing aggregate demand. Increased spending boosts economic demand; decreased spending slows it.

Taxation collects government revenue from individuals and businesses. This includes income taxes on earnings, corporate taxes on business profits, and sales taxes on goods and services. Changes in tax rates or the overall tax structure directly affect disposable income for consumers and business profitability. For instance, lower taxes can leave more money for individuals to spend or invest, stimulating consumer demand and business activity. Conversely, higher taxes reduce disposable income and slow down economic activity.

Fiscal policy can be either expansionary or contractionary. Expansionary fiscal policy, typically used during economic downturns or recessions, increases spending or decreases taxes to stimulate growth and aggregate demand. Contractionary fiscal policy decreases spending or increases taxes to curb activity. It is used when the economy overheats or has high inflation, reducing aggregate demand and stabilizing prices.

Responsible Bodies in Fiscal Policy

In the United States, fiscal policy involves the legislative and executive branches. They collaborate on federal spending and taxation decisions.

The legislative branch, primarily the U.S. Congress, holds the constitutional power of the purse. It enacts tax laws, approves the federal budget, and authorizes government spending. Congress passes legislation determining revenue collection and fund allocation.

The executive branch, led by the President and supported by agencies like the Treasury Department and the Office of Management and Budget (OMB), proposes and executes fiscal policy. The President submits an annual budget proposal to Congress, outlining spending and taxation priorities. The executive branch manages revenues and expenditures, ensuring funds are disbursed per appropriations.

Fiscal policy is distinct from monetary policy, although both are crucial for managing the economy. Monetary policy, managed by an independent central bank like the U.S. Federal Reserve, involves managing the money supply and interest rates. Monetary policy influences the economy via financial markets, while fiscal policy directly impacts activity through spending and taxation.