Edited by William F. Shughart II, Laura Razzolini and Michael Reksulak
Chapter 16: Fiscal policy
Fiscal policy is one of three major policy tools (the others being monetary policy and regulation) used by government to influence the private economy. For some time now, monetary policy – money rules and inflation targeting – has been the focus of policy attention at the aggregate level (Blinder 2006), while regulation/deregulation issues have preoccupied policy analysts at the micro level. However, the events of the last few years, particularly those associated with the 2007–08 financial crisis, have reawakened interest in fiscal policy. In part this is due to the perceived failure of financial regulation to prevent the crisis and the concomitant failure of traditional monetary policy (the hitting of the zero interest rate bound) to moderate the subsequent recession. There are now new fears over the consequences of the huge deficits accumulating to deal with the ongoing recession. Fiscal policy refers to the government’s ability to tax and spend either to influence the economy directly, or to realign the incentives facing private agents and so restructure the economy indirectly. From a public choice perspective, fiscal policy raises a host of collective choice problems associated with how citizens use or abuse the powers of the state to achieve private and collective objectives. From a macro perspective, public choice considerations raise issues associated with endogenizing government within formal macro models.
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