Understanding How the Government Stimulates the Economy

A constant subject of debate and concern in the political arena, the economy remains to be a highly debated topic. Stimulating the economy is accomplished in one of two ways. The government can increase government spending or decrease taxes.

Essentially, in the short term, increased spending will stimulate the economy much faster than tax reductions. It is imperative to remember that government spending to stimulate a slow economy is not free. Eventually, the choice to increase spending leads to its consequences. Increasing government spending may be necessary in the short run in a slow economy, but it will lead to less investment spending by individuals and businesses as well as slower potential long-term growth.

All government spending, even for necessary expenses like military equipment, needs to be viewed in this light. Any money spent by the government must be accounted for either by increasing taxes, increasing debt, or reducing spending in some other area of the government. However, economic stimulation through tax reductions is more effective in the long term because tax reductions also stimulate investment, which government spending does not do.

Fiscal policy is the plan by the government to influence the economy by using it as a component in aggregate demand and using its ability to drain the economy through taxes. The government uses three tools of fiscal policy to influence the economy. The tools are taxes, government spending and transfer payments.

Taxes help the government influence the amount of goods and services purchased by the general public. Government spending refers to the purchase of goods and services by the government, and direct payments are payments from the government to the general public for benefits like unemployment and Social Security.