Fiscal policy

Fiscal Policy is the economic term which describes the behaviour of governments in raising money to fund current spending and investment for collective social purposes and for transfer payments to citizens and residents of the territory for which the government is responsible. The money may be raised by taxation, by borrowing, by fiat (ie the government declaring a particular token to be money and demanding that it be accepted in settlement of debts) or by user charges on social assets or services.

A government which wishes to borrow from foreign citizens will need to maintain accounts to allow potential creditors to assess its credit worthiness. These accounts are typically maintained on an annual basis giving rise to a fiscal year. In each fiscal year a government will have a total income (its revenue) and a total expenditure. The latter minus the former is the fiscal deficit (or fiscal surplus if negative). Year on year the fiscal deficit adds to (or reduces) outstanding government borrowing. If government debt is denominated in the government's own currency, then it will be devalued in line with the country's domestic inflation. Under crisis conditions a government may choose to default on (ie repudiate) its foreign (or more rarely) its domestic debt.

A government will pay interest on its outstanding debt. This must be paid out of revenue. For this reason a government will typically aim to ensure that its fiscal deficit averaged over the business cycle is no greater than the share of state spending of gross domestic product multiplied by the sustainable rate of growth of gross domestic product. The government's detailed decisions in this arena form its fiscal policy.