Fiscal policy is one of two major sets of policy tools that governments can employ to manage the economy. Fiscal policy is the use of changes in taxes and government expenditure to influence aggregate demand and thus the level of economic activity. Government expenditure, that is, government spending on goods and services, is a component of aggregate demand, while tax rates affect either consumption or investment expenditure, which are components of aggregate demand. Fiscal policy can either be expansionary, which means it attempts to increase aggregate demand, or contractionary, which means it attempts to decrease aggregate demand.
Government expenditures and tax revenues are the two sides of the government budget. Since most states in the U.S. are statutorily required to run balanced budgets, fiscal policy usually refers to spending and tax changes by the federal government.
Self Check: Fiscal Policy and Tax Rates
Answer the question(s) below to see how well you understand the topics covered in the previous section. This short quiz does not count toward your grade in the class, and you can retake it an unlimited number of times.
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Use this quiz to check your understanding and decide whether to (1) study the previous section further or (2) move on to the next section.