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1 1 (December 29, 2022)

handle is hein.crs/govejzh0001 and id is 1 raw text is: Congressional Research Service Informing Ih legisIlive dba e sinceo 1914 Introduction to U.S. Economy: Fiscal Policy What Is Fiscal Poly? Fiscal policy is the means by which the government adjusts its budget balance through spending and revenue changes to influence broader economic conditions. According to mainstream economics, the government can affect the level of economic activity-generally measured by gross domestic product (GDP)-in the short term by changing its levels of spending and tax revenue. This In Focus presents an introduction to fiscal policy. For a more in-depth look at fiscal policy, its effect on the economy, and its use by the government, refer to CRS Report R45723, Fiscal Policy: Economic Effects, by Lida R. Weinstock. Fiscal policy is often characterized by its countercyclical or procyclical nature. Countercyclical policy attempts to counteract the business cycle by promoting growth through expansionary policy during a recession and preventing overheating through contractionary policy during an expansion. Procyclical policy does the opposite and is generally seen to be counterproductive, potentially overheating the economy during expansions and further dampening growth during recessions. Expansionary Fiscal Policy Recessions can have negative consequences for both individuals and businesses. During a recession, aggregate demand (overall spending) in the economy falls, which generally results in slower wage growth, decreased employment, lower business revenue, and lower business investment. As such, policymakers may want to intervene in the economy when a recession occurs by implementing expansionary fiscal policy to mitigate the decline in aggregate demand. Expansionary fiscal policy-an increase in government spending, a decrease in tax revenue, or a combination of the two-is expected to temporarily spur economic activity. Increased government spending can take the form of both purchases of goods and services by the government, which directly increase economic activity, and transfers to individuals, which indirectly increase economic activity as individuals spend those funds. Decreased tax revenue via tax cuts also indirectly increases aggregate demand in the economy. For example, an individual income tax cut increases the amount of disposable income available to individuals, enabling them to purchase more goods and services. Standard economic theory suggests that in the short term, fiscal stimulus can lessen a recession's negative impacts or hasten a recovery. Expansionary fiscal policy's effectiveness may be limited by its interaction with other economic processes, including Updated December 29, 2022 interest rates and investment, exchange rates and the trade balance, and the rate of inflation. First, assuming no action from the Federal Reserve, expansionary fiscal policy is expected to result in rising interest rates, which puts downward pressure on investment spending in the economy. Second, it can lead to a strengthening U.S. dollar, which results in a growing trade deficit. Third, it can lead to accelerating inflation in the economy; although this was not the case during the 2009-2020 expansion. All of these side effects from expansionary fiscal policy tend to put downward pressure on economic activity, and therefore work against the original stimulus generated through expansionary fiscal policy. Expansionary fiscal policy's ultimate effect on the economy depends on the relative magnitude of these opposing forces. In general, the increase in economic activity resulting from expansionary fiscal policy tends to be greatest during a recession, when the economy has more room to expand, and the negative side effects are somewhat counteracted by the recession itself, monetary policy, or both. Contractionary Fiscal Policy As the economy shifts from a recession and into an expansion, broader economic conditions generally improve, with falling unemployment and increasing wages and private spending. With improving economic conditions, policymakers may choose to begin withdrawing fiscal stimulus by decreasing the size of the deficit or potentially by applying contractionary fiscal policy and running a budget surplus. Contractionary fiscal policy-a decrease in government spending, an increase in tax revenue, or a combination of the two-is expected to temporarily slow economic activity. When the government raises individual income taxes, for example, individuals have less disposable income and generally decrease their spending on goods and services in response. The decrease in spending temporarily reduces aggregate demand for goods and services, slowing economic growth temporarily. Alternatively, when the government reduces spending, it reduces aggregate demand in the economy, which again temporarily slows economic growth. As such, aggregate demand is expected to decrease in the short term when the government implements contractionary fiscal policy, regardless of the mix of fiscal policy choices. However, contractionary fiscal policy has the same caveats as expansionary fiscal policy, except in reverse. Contractionary fiscal policy is expected to reduce interest rates, leading to additional investment, and weaken the U.S.

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