What the Heck is Fiscal Policy, Anyway?

Newspapers, politicians, and economists talk a lot about fiscal policy. But we often forget that not everyone understands what “fiscal policy” is.

In a nutshell, fiscal policy is how much governments choose to tax and spend, and thus how much they choose to borrow or (theoretically) save.

During recessions, economies have what economists call “inadequate demand”, or, looked at another way, “excess capacity”. Too many people are out of work. Left alone, economies should eventually recover from recessions on their own, without any help from the government or anyone else. However, this can take years, as we’re currently seeing in the U.S. In the meantime, millions of people suffer.

One way to address this is for the government to spend more than it takes in. It can do this either by increasing spending, decreasing taxes, or both. This is called deficit spending. It’s also called fiscal stimulus. Increasing deficit spending always provides fiscal stimulus to the economy. And providing fiscal stimulus always requires increasing deficit spending (or decreasing any fiscal surplus, if you’re fortunate enough to have one).

The problem with fiscal stimulus, though, is that you have to borrow money to do it. Essentially the government has to force the country as a whole to spend more today by spending less in the future.

This actually can make sense if the country is in a recession, and most economists agree that governments should run deficits during recessions. The problem is that during economic expansions, governments need to either be paying down debt by running a government surplus, or at least not be running a deficit. That’s where governments seem to have a problem.

Of course, no government can continue to borrow more and more money at an increasing rate indefinitely. Eventually no one’s going to be willing to loan them any more money. Even before it gets to that point, though, the country is likely to see its costs of borrowing increase. Not to mention the fact that the country will have to pay interest on that debt until they manage to pay it off.

Where exactly public debt begins to be a huge problem is hard to pinpoint, and it depends on many different global economic factors. Right now, Japan’s public debt is over 230 percent of its GDP, and it’s still able to raise funds. On the other hand, Greece’s debt is around 170 percent of GDP, and it’s a fiscal basket case.

According to the U.S. Treasury, the U.S.’s public debt was $16.2 trillion as of 5 October 2012. Given our second quarter GDP of $15.6 trillion, that comes out to 104 percent of GDP.

Despite this, the consensus among economists is that we still can’t afford to decrease government spending in 2013. Most economists surveyed feel that we still need that fiscal stimulus to keep the economy from falling back into recession.


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