SSEMA3 The student will explain how the government uses fiscal policy to promote price stability, full employment, and economic growth.

a. Define fiscal policy

Fiscal policy refers to the power of the government (federal, state, or local) to use government spending and taxation policy changes to influence economic activity. The two main tools of fiscal policy are changes in taxes and changes in government spending. Fiscal policy changes are usually proposed by the executive branch of government and incorporated into a bill which must be passed by the legislative branch into law. In some cases, existing laws can allow automatic fiscal policy changes without new legislation.

Fiscal policy A good example of an “automatic stabilizer” fiscal policy is the current federal progressive income tax system. In times of inflation, people’s wages rise causing their tax burden to rise, lowering consumer spending and price level. In times of recession, wages will fall and people will pay less in taxes, allowing them to spend some additional income.

b. Explain the government’s taxing and spending decisions.

contractionary fiscal policy During a time of increasing price level, the government may decide to pursue contractionary fiscal policy to curb inflation. The fiscal policy tools used to combat inflation include lowering government spending or increasing taxes. Less government spending means fewer firms and workers are earning money from government contracts and jobs. This lowers consumption, investment, and government spending. When spending decreases, prices eventually fall reducing inflation.

fiscal policy tools that increase spending in the economy When the government wishes to promote full employment and economic growth at a time when price level is not a concern, it will use fiscal policy tools that increase spending in the economy. This includes lowering taxes so people have more of their income to spend as well as increasing government spending so more firms and workers can earn money from government contracts and jobs.