The concept of fiscal policy is the level of government spending and taxation set by the president and congress. Fiscal policy contains short term and long term effects; short run effects include fiscal policy on aggregate demand for goods and services. Long term effects are better saving and investments over the period of time. The government goes about changing the prices to obtain a stable prices, low unemployment and high growth. In the united states the legislative and executive branch is in charge of putting the policy in place. Fiscal policy can be used to stimulate a sluggish economy or slow down an economy that is growing too rapidly.
Prior to the Great Depression the nation maintained economic stability by sustaining a balanced budget, soon they found out that more had to be done. President Roosevelt was the first to apply fiscal policy into the government’s economic system. When this policy was first implemented it didn’t seem to have great success and scholars report this was in part of the current economic condition as this was during the middle of the Great Depression. The late 1930’s proved to be the point when the fiscal policy was out into place most effectively. As WWII started employment rose, and the New Deal was implemented. This allowed government relief and new government organizations. The New Deal is actually what fueled the progress of fiscal policy. This was the first the government had intervened to help the citizen’s with their financial burdens and helped ease the economic tensions in society. Regardless of all of these drawbacks the fiscal years of American history is known to be between 1970 to 1997, where the government was most heavily concentrated in debt and deficit.
Expansionary fiscal policy is when we stimulate the aggregate demand. We can increase government spending or decrease taxation. Contractionary fiscal policy is a drag on aggregate demand, we can decrease and government spending and higher taxes. Clearly the general public sides with expansionary fiscal policy because this takes less away from the people. However, this his its drawbacks as it increases debt. Earlier we learned that if government spending is more then the tax revenues (G>T) that a deficit is created and this is what is happening with expansionary fiscal policy. Although this may please many citizens at the current time we have to keep in mind long term objectives.
Looking at it from an international point of view, changing the exchange value of a dollar hurts the fiscal policy. The international effect of expansionary fiscal policy increases the budget deficit, the need for government borrowing thus leading to the increase of demand for loanable funds. This increases the interest rate which in turn increases the demand for dollars in the foreign exchange market. This is because foreigners are more interested in being a part of bonds and saving accounts and investing in American funds. The increase in the demand of a dollar while make it more expensive for Americans to export because if one dollar is worth more yens it is more expensive for foreigners to buy. However, The stronger dollar makes foreign good stimulates imports to the US, this makes foreign goods and services less important (in terms of dollars) The main goal is to reduce the net exports, this leads to a negative influence on aggregate demand. However the main goal of fiscal policy is to raise aggregate demand with then country but lower it internationally. The international effect weakens the fiscal policy becasu eof interest rates, value of dollar and net exports.
Contractionary fiscal policy is the reeducation of demands for loanable funds and this lowers interest rates . This causes the exchange value of the dollar to fall. By lowering government spending and consumption we are trying to lower aggregate demand. By lowering deficit we lower the amount of loanable fund, this lower interest rates, and this leads to lower foreign interest in the dollar and reduces values of a dollar. This helps US exports making it cheaper to sell overseas, but reduces foreign imports because it costs more of the US dollar to purchase the good. The effect is to increase net exports, this is a positive influence on aggregate demand and weakens contractionary fiscal policy, due to lower interest rates we end up with a weaker dollar and stimulates aggregate demand.
The overall concept and driver of fiscal policy is spending and taxation. We see that both types of fiscal policies have their pros and cons, although there may not be ne policy that can fix every economic trial, we see that a combination of them can be beneficial. Also the use of fiscal policy depends heavily on the goal and what is the intended result from the changes in spending and taxation.