Fiscal policy refers to the use of government expenditure, tax, and borrowing activities to achieve economic goals, including the overall level of aggregate demand in an economy (and hence the level of economic activity), the distribution of income and wealth among different segments of the population, and, ultimately, the allocation of resources between different sectors and economic agents.

Keynesians believe fiscal policy can greatly affect aggregate demand, output, and employment. Monetarists represent a different school of thought, believing that fiscal policy has only a temporary impact on aggregate demand and that monetary policy is the most effective means of addressing inflationary pressures.

Governments can increase spending (expansionary policy) to boost the economy or cut back on spending (contractionary policy) to slow it down. For example, expansionary fiscal policy could include cutting personal income, sales, or corporate tax.

Deficits and the National Debt

Often, the government revenue and government expenditures are measured as a percentage of GDP. Government deficits are the difference between government revenues and expenditures over a time period. A budget deficit exists when total government spending exceeds government revenue. A budget deficit is financed through the issuance of government securities. Such issuance of securities adds to the national debt.

There are arguments for and against being concerned with the size of a fiscal deficit.

The arguments against being concerned about national debt:

• The debt is owed internally by fellow citizens.
• Some borrowed money may have been used for capital investment projects or enhancing human capital.
• Large deficits require tax changes which may be desirable.
• Richardian equivalence: the timing of any tax change does not affect consumers' change in spending.
• Debt could improve employment.

The arguments for being concerned about national debt:

• Higher deficits -> higher tax rates -> less incentive to work and invest -> lower long-term growth
• The central bank may have to print money to finance a deficit. This may lead to high inflation.