American Politics Today - Essentials (3rd Ed)

ECONOMIC POLICY| 437

Tools and Theory of Economic Policy

Here we explore the various tools that policy makers use to achieve the goals out-

lined in the previous section. We do not want to give the impression that policy

makers can pull levers and push buttons to achieve desired outcomes, or that they

are immune from external forces that can sink the economy despite their best

eff orts. However, leaders can do certain things to move the massive U.S. economy

in the right direction.

FISCAL POLICY

Fiscal policy is the use of the government’s taxing and spending power to infl uence
the direction of the economy. In the 1930s the economist John Maynard Keynes
developed the idea of fi ne-tuning the economy through “countercyclical” taxing
and spending policy, usually called Keynesian economics. Keynes argued that
policy makers can soften the eff ects of a recession by stimulating the economy
when overall demand is low—during a recession, when people aren’t spending
much—through tax cuts or increased government spending. Tax cuts put more
money in people’s pockets, enabling them to spend more than they otherwise
would, while government spending stimulates the economy through the purchase
of various goods, such as highways or military equipment, or direct payments to
individuals, such as Social Security checks. From this perspective it is acceptable
to run budget defi cits in order to increase employment and nationa l income to give
a short-term boost to the economy. Keynes also pointed out that if overall demand
is too high, which might result in infl ation, policy makers should cool off the econ-
omy by cutting spending or raising taxes.^12
A more recent version of fi scal policy was the basis for Ronald Reagan’s tax cuts
in 1981 and has been the centerpiece of economic policy for many Republicans since

Keynesian economics The

theory that governments should

use economic policy, like taxing and

spending, to maintain stability in the

economy.

Budget defi cits and the federal debt are related concepts that are easily confused.

¾ A budget defi cit occurs when tax revenue is not suffi cient to cover government

spending in a given year. If tax revenue is higher than spending, then there is a

budget surplus.

¾ The federal debt is the total accumulation of all outstanding borrowing by the

government.

¾ The concepts of defi cit and debt are related because when the government runs a

defi cit, it must borrow money to cover the gap. This borrowing then builds up the

federal debt.

You can think of this in terms of your own spending habits. Any time you spend more

money in a given month than you earn, you are running a defi cit. You must borrow

money to make up that defi cit from a bank, from your parents, or by running up the

balance on your credit card. The accumulated sum of your monthly defi cits is the total

debt that you owe.

DEFICITS AND DEBT

NUTS & bolts

14.1