Fiscal policy is a term that used to describe the actions taken by the government to facilitate economic activity. This policy comprises of a combination of how the government taxes citizen and how it spends the proceeds. During a recession, the government can use fiscal policy to help stimulate the economy.
When it comes to how fiscal policy affects the economy during a recession, the government has some automatic stabilizers in effect. These items work to automatically stabilize the economy when a recession takes place. For example, the income tax system acts an automatic stabilizer. When people make less money, they also pay less money in income taxes. Unemployment benefits are another example of an automatic stabilizer. This helps families continue to receive income so that they can keep spending and keep the economy going.
When the economy is struggling during a recession, the government can attempt to help the situation by charging less in taxes. In many cases, the executive and legislative branches work together to cut taxes for Americans. By doing this, it gives people more discretionary income so that they can spend and stimulate the economy. Once the economy stabilizes, the government can gradually reintroduce the taxes and help keep the economy and the government going.
Increase Government Purchases
Another way that the government can uses fiscal policy to stabilize the economy during a recession is to increase government purchases. The government can use more money to buy goods and services from domestic providers. This increase in sales helps stimulate the businesses. These businesses can then use this increase in income to buy more supplies and expand even further. Once this begins to happen, it can have a positive effect on the entire economy and stabilize the recession by providing more jobs and opportunities for unemployed Americans.
Expansionary vs Contractionary
One of the arguments among economics on how to use fiscal policy centers around expansionary and contractionary strategies. An expansionary fiscal policy involves increasing government expenditures or lowering taxes so that the deficit increases. By comparison, a contractionary fiscal policy cuts back on government expenditures or increases taxes so that the government can have a financial surplus. Using an expansionary policy can improve the economy in the short-term, but eventually it could hurt the economy as the government's debt becomes too large.