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fiscal policy

Page history last edited by Brian D Butler 13 years, 3 months ago


Fiscal Stimulus:

for our discussion on fiscal stimulus, please visite here:.


Fiscal Policy

"Tax and spend". 


The Fiscal policy is one way in which a government can spur growth (and jobs) in a country.  The other way is monetary policy.  While the goals of the two systems might be similar, the mechanism and the results are quite different.  Many economists spend their entire lifetimes debating the optimum way to accomplish growth & employment, without causing inflation or high interest rates.



Note:  Fiscal stimulus spending on infrastructure pushes out the POTENTIAL GDP - not the current actual GDP



Table of Contents:





Fiscal Vs. monetary Policy....what is the difference?

If the government is trying to stimulate the economy (get new jobs):

The key differences between the two are as follows: 

  1. Monetary policy: 
    • What: federal funds rate, discount rate
    • Who:  Central Bank (the Federal Reserve)
    • How:  increase / decrease money supply (to raise / lower interest rates, which will encourage investment or savings)
    • Where does the money come from:  federal reserve prints new money, which enters the system when treasury buys back bonds from the market
    • Effects:  interest rates down, currency depreciates
  2. Fiscal Policy:
    • What:  government spending
    • Who:  treasury department (its not the central bank, so they can not print more money)
    • How: spend money (new roads, buildings, projects, etc)
    • Where does the money come from:  either (a) raise taxes, or (b) borrow money by issuing new bonds
    • Effects:  interest rates go up, currency appreciates



How Fiscal Policy works:


Increases in government purchases of goods and services directly increases spending; tax reductions or increases in transfers rise disposable income and induce higher consumption. Tax incentives like an investment tax credit can induce higher spending in a particular sector.




Question:"what happens when the government starts spending?"

  1. Currency will appreciate appreciation
  2. interest rates will go up
  3. inflation will increase (this happens second, over lots of time).


Why do they start spending

  1. The goal is to stimulate the economy and generate jobs
  2. It pushes out the aggregate demand curve (movement along the supply curve), which increases output/ consumption at every price level


Where does the money come from?

  1. The government can either (a) raise taxes, or (b) sell new bonds
  2. since raising taxes is very unpopular, the gov't almost always sells new bonds (borrowing money from the public)
  3. How do they get people to buy the new bonds?
    • by offering a higher interest rate...stimulate people to buy
    • give incentive for people to lend money to the government


What effect does this have on FX rates?

  1. Currency will appreciate immediately


  2. Because foreigners see higher interest rates


What effect does this have on inflation?

  1.  over time, there will be more inflation
  2. but, in this case, its not because of more money supply





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