Fiscal policy

Fiscal policy is how the federal government uses its two big economic levers — taxation and government spending — to steer the economy. It is set by Congress and the President through the budget and tax laws they enact. This is the key contrast with monetary policy, which is conducted by the Federal Reserve through interest rates and the money supply.

Fiscal policy comes in two flavors. Expansionary fiscal policy — cutting taxes or increasing government spending — puts more money in the hands of consumers and businesses to stimulate a sluggish economy. Contractionary fiscal policy — raising taxes or cutting spending — pulls money out of the economy to cool inflation. Expansionary policy tends to widen budget deficits, while contractionary policy shrinks them.

The intellectual foundation is Keynesian economics, which holds that total demand drives economic output and that government intervention can smooth out booms and busts. Critics note that fiscal policy moves slowly — legislation takes time to pass and even longer to ripple through the economy — which is one reason day-to-day economic management falls mostly to the faster-acting Federal Reserve.

Fiscal policy is a dependable exam topic in the economics sections of the securities exams. The SIE and Series 65 exams both test who controls fiscal policy (Congress and the President), the difference between fiscal and monetary policy, and which tools — taxes and spending versus interest rates and open market operations — belong to each.