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Fiscal Policy*

Fiscal Policy refers to government spending more specifically the use of government budget to effect the economy. The primary tool is taxation. Depending on how much is taxed, what is taxed and who is taxed the government can change the spending patterns, this is further assisted by what the state chooses to spend their revenues on, what percentage is spent and on what category of goods and services are supported.

The primary spending of a government is on defence and jurispurdance. Education, welfare, health and transportation are other important areas.

Governments obtain revenues primarily from taxation but it has other sources. Seigniorage, borrowing, reserve spending and the sale of fixed assets such as land all serve to enable government sepending.

Two observation justify fiat policy. There appear to be some services that cannot be adequately provided by the private sector. The private sector also is prone to irrational exuberance and bottomless fear. In 1936 during the Great Depression when fear was so palable that not even zero interest rates could break through what is now called a liquidity trap.

Economic expansion cannot be generated if the private sector is too adverse to risk to invest. In such cases Keynes thought it best for governments to spend even if this meant borrowing. The assumption was that whatever debt was incurred could be paid off by the resultant expansion.

As we have seen Monetary Policy involves increasing or contracting the money supply. At one time this was done by the simple expedient of printing more of it. But a too casual use of the printing press seriously impacts investors confidence. Indeed a too liberal hand on the lever may actually compound the distrust with which the Money Supply is viewed. Few people will lend money when it seems likely its value is likely to drop precipitously before the loan is repaid.

 So for many economists and statesmen Monetary Policy has been found wanting. If it is not sufficient to offer money to borrow then the state must borrow and spend itself. Depending on the circumstance the state may find it has sufficient income by taxing its citizens, in severe downturns or times of great need as in a way it may have to borrow. This is Fiscal Policy but the two are not as seperated as one might wish.

The trouble with Monetary Policy being equated with the printing of money or more broadly the issuance of money. The difficulty we have with this understanding is that in modern economies the Money Supply tends to be expanded by lowering interest rates and contracted by increasing the rate at which money may be borrowed. This has the possibility of increasing the amount of currency in circulation but has the Money Supply truly increased or been contracted?

Money is often defined as a medium of exchange. This suggests very strongly that money is something solid. Gold of course is the preeminent medium of exchange because it is valuable in itself, easily divided into different weights and is generally valued in its own right. So many there are that favour a return to the Gold Standard. But gold cannot be supplied in the quantities needed to maintain liquidity in a rapidly growing economy.

What so many have found out is that Monetary Policy can rarely be distinquished from Fiscal Policy. When governments wish to make more money fiscal deficits are often funded by financial instruments that are forms of money. Bonds, such as treasury bills and consols are bought and sold as if they were assets but as financial instruments they serve as backing for the issuance of additional currency.

Which brings in the issue of debt.

 A currency note is an I.O.U. payable by the economy.  The state guarantees that a bank note can be used to pay ones bills. Creditors are required by law to accept dollar bills or whatever currency the state uses. These bills are money by fiat, by legislative order.

Uncreasing the money supply usually means the supply of money is expanded by fiat on the basis of state credit or government borrowing or a reduction in the interest rate all of which reduces the value of the bills in circulation. Modern economies all have a background rate of inflation. It is important to understand what is really the rate at which money decays to understand what is happening in the economies of the world.







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