Draft:Fiscal policy

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Fiscal policy is government policy on taxes, spending, and borrowing that is designed to influence business fluctuations. It is one of the two most important macroeconomic tools that a government has to stabilize the economy, along with monetary policy.

How it works (or at least how it should)[edit]

In theory, a fiscal policy would be counter-cyclical: spending more in bad times and spending less in good times to offset declines and increases in private spending.

Tax-cutting vs. Government spending[edit]

From a pure mathematical perspective, we expect that government speding will have a bigger multiplier effect than cutting taxes, and, as a result, will stimulate the economy more.

Problems and criticism[edit]

Despite being a powerful tool, fiscal policy also saw its share of criticism, and as a result, it lost much space to monetary policy. Here are some of the reasons:

The crowding-out effect[edit]

Fiscal policy and floating exchange rate[edit]

The Public Choice critique[edit]

Politics[edit]

Ricardian equivalence[edit]

The case for fiscal policy nonetheless[edit]

Despite its shortcomings, there are least some situations where fiscal policy works very well.

Liquidity trap[edit]

This is the case where fiscal policy works the best, while monetary policy doesn't work.

Fiscal policy and emergencies[edit]

The case for government spending is also strong when a country faces some immediate emergency, such as a war, a pandemic, or a natural disaster.