There are two powerful tools our government and the Federal Reserve use to steer our economy in the right direction: fiscal and monetary policy. When used correctly, they can have similar results in both stimulating our economy and slowing it down when it heats up. The ongoing debate is which one is more effective in the long and short run.
Fiscal policy is when our government uses its spending and taxing powers to have an impact on the economy. The combination and interaction of government expenditures and revenue collection is a delicate balance that requires good timing and a little bit of luck to get it right. The direct and indirect effects of fiscal policy can influence personal spending, capital expenditure, exchange rates, deficit levels and even interest rates, which are usually associated with monetary policy.
Fiscal Policy - the Keynesian School
Fiscal policy is often linked with Keynesianism, which derives its name from British economistJohn Maynard Keynes. His major work, "The General Theory Of Employment, Interest And Money," influenced new theories about how the economy works, and is still studied today. He developed most of his theories during the Great Depression and Keynesian theories have been used and misused over time, as they are a popular and are specifically applied to mitigate economic downturns.
In a nutshell, Keynesian economic theories are based on the belief that proactive actions from our government are the only way to steer the economy. This implies that the government should use its powers to increase aggregate demand by increasing spending and creating an easy money environment, which should stimulate the economy by creating jobs and ultimately increasing prosperity. The Keynesian theorist movement suggests that monetary policy on its own has its limitations in resolving financial crises, thus creating the Keynesian versus the