The fiscal stance is the way the government adjusts its expenditure and taxes to affect the economy. It involves government discretion as to its budgetary policy orientation.
Fiscal policy is a complement for monetary policy through which the central bank influences a country’s money supply. Both aim to influence aggregate demand.
How to assess the fiscal stance
The overall balance is an indicator of determining fiscal policy stance. It measures the difference between revenue and grants and net expenditure and net lending. This statistic may be in deficit or surplus.
As a starting point for analysis, the overall deficit will represent an expansionary stance. A deficit means that government spending is more significant than revenue, primarily from taxes.
Government spending increases aggregate demand. Meanwhile, tax revenue discourages aggregate demand. Thus, the deficit illustrates the government’s efforts to increase aggregate demand.
Conversely, a surplus represents a contractionary stance. That’s because expenditure is smaller than tax revenue.
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Both of those stances are needed to ease the negative economic cycle. The expansionary stance seeks to avoid a recession by stimulating economic growth. Meanwhile, the contractionary stance aims to prevent the economy from overheating and hyperinflation.
Contra-cyclical components effect
The actual budget position of the government does not necessarily reflect the fiscal stance. It misleads if you infer the government’s budgetary stance only from actual tax revenue and expenditures.
Fiscal budgets contain counter cycle components such as automatic stabilizers that are irrelate to government stance — for example, unemployment benefits.
During a recession, deficits might occur due to increased unemployment benefits, although other components unchanged from the previous. Hence, the increased expenditure is not due to government discretion but occurs automatically because, indeed, the unemployment rate increases during the recession. So, in this case, the budget deficit does not signal a fiscal policy stance.
Conversely, during expansion, the budget tends to be surplus due to decreased unemployment benefits. During the economic expansion, the unemployment rate falls because of the demand for labor increases. As a result, spending on unemployment benefits also falls.
