Editing Fiscal policy (section)

==Economic effects==
{{More citations needed|date=July 2024}}{{See also|Gross fixed capital formation#Economic analysis}}

Governments use fiscal policy to influence the level of aggregate demand in the economy, so that certain economic goals can be achieved:<ref>{{Cite web |date=2025-02-21 |title=What is fiscal policy and how does it affect the economy? |url=https://www.britannica.com/money/fiscal-policy |access-date=2025-02-28 |website=Britannica Money |language=en}}</ref>
*Price stability;
*Full employment;
*Economic growth.

The [[Keynesian economics|Keynesian]] view of economics suggests that increasing government spending and decreasing the rate of taxes are the best ways to have an influence on [[aggregate demand]], stimulate it, while decreasing spending and increasing taxes after the economic expansion has already taken place. Additionally, Keynesians argue that expansionary fiscal policy should be used in times of [[recession]] or low economic activity as an essential tool for building the framework for strong economic growth and working towards [[full employment]]. In theory, the resulting deficits would be paid for by an expanded economy during the expansion that would follow; this was the reasoning behind the [[New Deal]].
[[File:Islm.png|alt=ISLM model graph|thumb|217x217px|The IS curve shifts to the right, increasing real interest rates (r) and expansion in the "real" economy (real GDP, or Y).]]
The [[IS–LM model|IS-LM model]] is another way of understanding the effects of fiscal expansion. As the government increases spending, there will be a shift in the IS curve up and to the right. In the [[Short-run|short run]], this increases the [[real interest rate]], which then reduces [[Private investment in public equity|private investment]] and increases aggregate demand, placing upward pressure on supply. To meet the short-run increase in aggregate demand, firms increase [[Full employment|full-employment]] output. The increase in short-run [[price level]]s reduces the [[money supply]], which shifts the LM curve back, and thus, returning the general [[Economic equilibrium|equilibrium]] to the original full employment (FE) level. Therefore, the IS-LM model shows that there will be an overall increase in the price level and real interest rates in the [[Long run and short run|long run]] due to fiscal expansion.<ref>{{Cite book|last=Acemoglu|first=Daron |title=Macroeconomics |date=2018 |author2=David I. Laibson |author3=John A. List |isbn=978-0-13-449205-6 |edition=Second |location=New York |oclc=956396690 |publisher=Pearson }}</ref>

Governments can use a [[budget surplus]] to do two things: 
*to slow the pace of strong economic growth;
*to stabilise prices when inflation is too high. 
Keynesian theory posits that removing spending from the economy will reduce levels of aggregate demand and contract the economy, thus stabilizing prices.

But [[economist]]s still debate the effectiveness of [[fiscal stimulus]]. The argument mostly centers on [[crowding out (economics)|crowding out]]: whether government borrowing leads to higher [[interest rate]]s that may offset the stimulative impact of spending. When the government runs a budget deficit, funds will need to come from public borrowing (the issue of government bonds), overseas borrowing, or [[Monetizing debt|monetizing]] the debt. When governments fund a deficit with the issuing of government bonds, interest rates can increase across the market, because government borrowing creates higher demand for credit in the financial markets. This decreases aggregate demand for goods and services, either partially or entirely offsetting the direct expansionary impact of the deficit spending, thus diminishing or eliminating the achievement of the objective of a fiscal stimulus. [[Neoclassical economics|Neoclassical]] economists generally emphasize crowding out while Keynesians argue that fiscal policy can still be effective, especially in a [[liquidity trap]] where, they argue, crowding out is minimal.<ref name="Cliff Notes, Economic Effecs of Fiscal Policy">{{cite web|url=http://m.cliffsnotes.com/study_guide/Fiscal-Policy.topicArticleId-9789,articleId-9749.html|archive-url=https://archive.today/20130410171108/http://m.cliffsnotes.com/study_guide/Fiscal-Policy.topicArticleId-9789,articleId-9749.html|url-status=dead|archive-date=April 10, 2013|title=Cliff Notes, Economic Effecs of Fiscal Policy|access-date=March 20, 2013}}</ref>

In the [[Classical economics|classical]] view, expansionary fiscal policy also decreases net exports, which has a mitigating effect on national output and income. When government borrowing increases interest rates it attracts foreign capital from foreign investors. This is because, all other things being equal, the [[Bond (finance)|bonds]] issued from a country executing expansionary fiscal policy now offer a higher rate of return. In other words, companies wanting to finance projects must compete with their government for capital so they offer higher rates of return. To purchase bonds originating from a certain country, foreign investors must obtain that country's currency. Therefore, when foreign [[capital flows]] into the country undergoing fiscal expansion, demand for that country's [[currency]] increases. The increased demand, in turn, causes the currency to appreciate, reducing the cost of imports and making exports from that country more expensive to foreigners. Consequently, [[export]]s decrease and [[import]]s increase, reducing demand from [[net export]]s.

Some economists oppose the [[discretionary policy|discretionary]] use of fiscal stimulus because of the [[inside lag]] (the time lag involved in implementing it), which is almost inevitably long because of the substantial legislative effort involved. Further, the [[outside lag]] between the time of implementation and the time that most of the effects of the stimulus are felt could mean that the stimulus hits an already-recovering economy and [[Overheating (economics)|overheats]] the ensuing [[Economic expansion|h]] rather than stimulating the economy when it needs it.

Some economists are concerned about potential inflationary effects driven by increased demand engendered by a fiscal stimulus. In theory, fiscal stimulus does not cause inflation when it uses resources that would have otherwise been idle. For instance, if a fiscal stimulus employs a worker who otherwise would have been [[Unemployment|unemployed]], there is no inflationary effect; however, if the stimulus employs a worker who otherwise would have had a job, the stimulus is increasing [[labor demand]] while [[Labour supply|labor supply]] remains fixed, leading to [[wage inflation]] and therefore [[Price Inflation|price inflation]].