FISCAL POLICY

Fiscal policy is an economic term used to describe government policies which aim to raise money in order to fund public spending and investment. This can be achieved in 4 ways:

1. Taxation
2. Borrowing
3. Charges users of social assets or services
4. By fiat (meaning that the government decrees a certain token to be taken as money on trust).

Fiscal policy also includes measures such as deficit spending, which may be used to boost economic growth and employment levels, or deficit reduction, which may be used to combat price level rises for example.

However, any government wanting to borrow money from abroad will be required to keep accounts in order to permit potential foreign investors to evaluate the country’s credit worthiness. In each fiscal year therefore, the government will have a total income (consisting of its revenue) and a total expenditure (consisting of its spending). This is known as a fiscal deficit if expenditure exceeds income, while the opposite case is referred to as a fiscal surplus.

This fiscal deficit or surplus is then summated on an ongoing and annual basis, which equates to total public sector borrowing (sometimes referred to as the national or public debt). If this borrowing is denominated in domestic currency terms, then rising domestic price levels caused by excess borrowing will mean that the real or inflation-adjusted costs of this borrowing will fall with time.

However, even though the real value of public debt may fall, the government is still required to pay interest on this outstanding debt, which may be done in two ways:

1. From tax revenue
2. By cutting public spending

Because of this, a central feature of most government policy is to ensure that public debt does not rise faster than the rate of growth in overall economic output and production over the entire course of the business cycle. However, exceptions to this policy is spending on vital infrastructure (such as transportation, education, public health, technological research and development etc), which has the potential to generate higher levels of potential economic growth over the long-term through its beneficial impact upon the supply-side of the economy.