The main goal of the state at all stages of its development is the stabilization of the economy. At the present time, the state actively uses the tools of intervention in the economy. The main 2 types of state intervention in the market economy include fiscal and monetary policies. Fiscal policy has been a key policy tool in addressing the aggregate demand consequences of the financial crisis in the United States. (Follette & Lutz, 2010)
Objectives of fiscal policy as any stabilization (countercyclical) policies aimed at smoothing cyclical fluctuations in the economy are to ensure:
Stable economic growth;
Full employment (primarily a solution to the problem of cyclical unemployment);
Stable price level (problem of inflation). (Strauch & Hagen, 2000)
Fiscal policy is the policy of the government regulation primarily aggregate demand. Regulation in this case occurs via the impact on spending. However, some fiscal instruments can be used to impact on aggregate supply through the impact on the level of business activity. Fiscal policy is conducted by the government.
Instruments of fiscal policy are the costs and revenues of the state budget, namely:
Public procurement;
Taxes;
Transfers. (Strauch & Hagen, 2000)
Depending on the phase of the cycle in which the economy, tools of fiscal policy are used differently. There are two types of fiscal policy such as expansionary and contractionary. A stimulating fiscal policy is applied when there is the downturn of economics and has the goal of reducing the recessionary output gap and unemployment, and aims to increase aggregate demand (total spending). The tools are increasing in government spending, tax reduction and increased transfers. Contractionary fiscal policy is used in the boom (overheating economy) and aims at reducing inflationary output gap and declining inflation and aims at reducing aggregate demand (total spending). The tools are reduction in public procurement, increasing taxes and a reduction of transfers. (O'Sullivan, Sheffrin, & Perez, 2008)
In addition, there are defined such types of fiscal policy as discretionary and automatic (non-discretionary). Discretionary fiscal policy is a legal change of the value of government purchases, taxes and transfers to stabilize the economy that is done by the government. Automatic fiscal policy is associated with the action of built-in (automatic) stabilizers. Built-in (automatic) stabilizers provide the tools, the value of which does not change, but the very existence of which automatically stabilizes the economy by stimulating business activity during a recession and restrain it in case of overheating. Automatic stabilizers include: income tax (including tax on income of households and the profit tax of corporations), indirect taxes (primarily the value added tax), unemployment benefits and poverty. (Langdana, 2016)
The advantages of fiscal policy include:
The multiplier effect. All instruments of fiscal policy, as we have seen, have a multiplier effect on the equilibrium value of aggregate output.
No external lag (delay). Outside lag is the period of time between the decision about the policy change and the emergence of the first results of its change. When the government made the decision to change the tools of fiscal policy, and these measures come into effect, the result of their impact on the economy manifests itself quickly enough.
The presence of automatic stabilizers. Since these stabilizers are built-in, the government need not take special measures to stabilize the economy. Stabilization (smoothing cyclical fluctuations in the economy) happens automatically.
Drawbacks of fiscal policy:
The crowding-out effect. The economic meaning of this effect consists in the following: growth of budget expenditures during the recession (increased government purchases and/or transfers) and/or reduction of budget revenues (taxes) leads to multiplicative growth of aggregate income, which increases the demand for money and increases the interest rate on the money market (the price of credit). And since the loans in the first place, take the company, the cost of loans leads to a reduction in private investment, i.e., to the "crowding out" of investment spending firms, which leads to a reduction in the magnitude of the issue. Thus, the part of total production is "pushed" (unproduced) due to the reduction in value of private investment expenditures as a result of rising interest rates by the government's stimulating fiscal policy.
The presence of internal lag. Inside lag is the time period between the occurrence of the need for changes in policy and decision-making. The decision to change the tools of fiscal policy taken by the government, but putting them into action is impossible without discussion and approval of these decisions by the legislative authority (Parliament, Congress, State Council, etc.), i.e. giving them the force of law. These discussions and approvals may require a longer period of time. In addition, they shall come into force starting from the following fiscal year, which further increases lag. During this period of time the economic situation may change. So, if initially the economy was in a recession, and measures are fiscal stimulus policies, the beginning of their actions in the economy may begin to rise. As a result, additional incentives may lead the economy to overheat and trigger inflation, i.e., to have a destabilizing effect on the economy. Conversely, measures constraining fiscal policy, developed in the boom period, due to the presence of long internal lag can exacerbate the downturn.
Uncertainty. This deficiency is characteristic not only for fiscal but also for monetary policy. Uncertainty concerns:
Problem identification the economic situation is often difficult to accurately determine, for example, the time when the recession starts a recovery, or the moment when the rise turns into overheating, etc. meanwhile, since the different phases of the cycle it is necessary to apply different policies (incentive or disincentive), the error in determining the economic situation and the selection of the type of economic policies based on such evaluation can lead to the destabilization of the economy;
Problems, on what kind of value you want to change the state policy instruments in each economic situation. Even if the economic situation is defined correctly, it is difficult to determine exactly how, for example, need to increase government purchases or cut taxes to ensure economic growth and the achievement of potential output, but not exceeding it, i.e. how to avoid overheating and accelerating inflation. Conversely, when conducting a limiting fiscal policy is not bringing the economy to a state of depression.
The budget deficit. Opponents of the Keynesian methods of regulating the economy monetarists (monetarists), supporters of the theory of supply-side Economics (supply side economics) and the theory of rational expectations (rational expectations theory) – i.e. the representatives of the neoclassical direction in the economic theory considered the state budget deficit one of the major drawbacks of fiscal policy. Indeed, the tools of fiscal stimulus policies during the downturn and aimed at increasing aggregate demand, is the increase in government purchases and transfers, i.e. expenditures budget and reducing taxes, i.e. revenues, which leads to the growth of the state budget deficit. Not by chance the recipes of state regulation of economy, proposed by Keynes, called "deficit financing".
Particularly acute problem of the budget deficit appeared in most of the developed countries that used after the world war, Keynesian methods of economic regulation in the mid 70-ies, and, in the United States there was the so-called "twin debts", in which the state budget deficit combined with a balance of payments deficit. In this regard, the problem of financing the state budget deficit has become one of the most important macroeconomic problems.
References
Follette, G. & Lutz, B. (2010). Fiscal policy in the United States: Automatic Stabilizers , Discretionary Policy Actions, and the Economy. Washington, D.C.
Langdana, F. (2016). Macroeconomic policy. Switzerland: Springer.
O'Sullivan, A., Sheffrin, S., & Perez, S. (2008). Macroeconomics. Upper Saddle River, NJ: Pearson Prentice Hall.
Strauch, R. & Hagen, J. (2000). Institutions, politics, and fiscal policy. Boston: Kluwer Academic.
