Fiscal Policy

The Federal Reserve Bank of Richmond, in a lesson on the topic, describes fiscal policy in slightly wider terms: the federal government's overall approach to spending, borrowing and taxation. The word borrowing is included because, as later sections explain, a government that spends more than it collects must borrow the difference.

Who Conducts Fiscal Policy

The St. Louis Fed states the division of responsibility in one sentence: the U.S. Congress and the administration conduct fiscal policy, while the Federal Reserve conducts monetary policy.

Treasury's Fiscal Data site describes discretionary spending as money formally approved by Congress and the President during the appropriations process each year.

The Federal Budget Year and Budget Process

Federal fiscal policy runs on a fiscal year. The Treasury Department states that the federal government operates on a fiscal year that begins on October 1 and ends on September 30. USA.gov likewise states that the fiscal year runs from October 1 of one calendar year through September 30 of the next.

USA.gov describes the budget process in steps. Federal agencies create budget requests and submit them to the White House Office of Management and Budget, which develops the budget proposal for the President. The President submits the budget proposal to Congress early the next year. The House and the Senate create their own budget resolutions, which must be negotiated and merged. Congress sends the approved funding bills to the President to sign or veto.

Not every appropriation follows the regular schedule. Fiscal Data explains that supplemental appropriations, also called supplemental spending, are appropriations enacted after the regular annual appropriations when the need for funds is too urgent to wait for the next regular appropriations.

Federal Revenue

Revenue is the money the government collects, and taxes are the main source. The Congressional Budget Office describes federal revenues as coming from taxes imposed on individual and corporate income, employers' payrolls, the production and importation of specific goods, and transfers of estates and gifts. Fiscal Data lists the sources in similar terms: individual income taxes, payroll taxes, corporate income taxes and excise taxes. It adds that the government also collects revenue from services such as admission to national parks, and from customs duties.

Treasury's accounting and budget FAQ states where the collected money goes: the tax money the federal government collects is placed into the General Fund of the Treasury to pay for essential government services.

Federal Spending: Mandatory and Discretionary

Federal spending falls into two broad groups, and the difference is how the money is authorized.

Mandatory spending is also called direct spending. Fiscal Data states that it is mandated by existing laws, and gives as examples funding for entitlement programs such as Medicare and Social Security, together with other payments to people, businesses, and state and local governments. The CBO describes mandatory spending as outlays for some federal benefit programs and certain other payments to people, businesses, nonprofit institutions, and state and local governments. USA.gov gives Social Security, Medicare and veterans benefits as examples of spending required by law.

Discretionary spending works differently. Fiscal Data describes it as money formally approved by Congress and the President during the appropriations process each year. The CBO states that funding for most discretionary programs is provided through annual appropriation acts and continuing resolutions, in the form of budget authority. USA.gov describes discretionary spending as federal agency funding, with Congress setting funding levels for it each year.

A third item is interest on the debt. The CBO describes net outlays for interest as the government's interest payments on debt held by the public, such as Treasury bills, notes and bonds, offset by interest income. Fiscal Data likewise notes that the government spends money on interest it has incurred on outstanding federal debt.

The CBO publishes a baseline, a set of detailed projections of federal spending, revenues, deficits or surpluses, and debt for the current year and the decade that follows. The CBO states that the baseline informs policymakers about budgetary trends and the nation's fiscal condition under current law.

Deficits, Surpluses and the National Debt

Fiscal Data defines the two budget outcomes. A budget deficit occurs when the money going out exceeds the money coming in for a given period. A surplus occurs when the government collects more money than it spends.

A deficit has to be financed. Fiscal Data states that to pay for government programs while operating under a deficit, the federal government borrows money by selling U.S. Treasury bonds, bills and other securities. It names marketable securities such as Treasury bonds, bills, notes, floating rate notes, and Treasury inflation-protected securities, known as TIPS.

The national debt is a separate measure. Fiscal Data defines it as the total amount of outstanding borrowing by the U.S. federal government accumulated over the nation's history. It also states that the national debt is the accumulation of this borrowing along with associated interest owed to the investors who purchased these securities. A deficit is therefore measured over a period, and the debt is the accumulated total.

Fiscal Data adds that the national debt can be broken down by whether it is non-marketable or marketable, and by whether it is debt held by the public or debt held by the government itself, which is known as intragovernmental debt.

Congress also sets a limit. Fiscal Data states that the debt ceiling, or debt limit, is a restriction imposed by Congress on the amount of outstanding national debt that the federal government can have. It states that once the debt ceiling is reached, the federal government cannot increase the amount of outstanding debt.

Expansionary and Contractionary Fiscal Policy

Two terms describe the direction of fiscal policy. The IMF describes expansionary, or loose, fiscal policy as policy that increases aggregate demand, and contractionary, or tight, fiscal policy as policy that reduces it.

The Richmond Fed lesson describes the levers and the effects. It states that increasing federal spending, reducing taxes, or both, can promote more employment and output, but can also put upward pressure on the price level and interest rates. It states that decreased federal spending, increased taxes, or both, tend to lower price levels and interest rates, but reduce employment and output levels in the short run.

Automatic Stabilizers

Not all fiscal policy results from a new decision. The IMF describes automatic stabilizers as cyclical changes in tax revenues and social spending that activate without new government actions.

The CBO gives a fuller definition. It states that automatic stabilizers are the components of federal revenues and outlays that automatically increase or decrease with cyclical changes in the economy to help strengthen a weakening economy or cool an overheating one. It states that these changes occur without any legislated changes in tax or spending policies, and that they help stabilize the economy by boosting or restraining private spending.

The CBO identifies specific components. When unemployment is relatively high, above the noncyclical rate of unemployment, federal outlays for unemployment insurance benefits, Medicaid benefits and Supplemental Nutrition Assistance Program benefits are greater than they otherwise would be, because more people qualify for benefits. When gross domestic product is below potential gross domestic product, tax revenues are typically smaller than they otherwise would be, because wages and salaries, corporate profits and other tax bases are smaller than they otherwise would be.

Discretionary Fiscal Action

The alternative to an automatic stabilizer is a deliberate decision by the government. The IMF article offers several observations about stimulus of that kind. It states that stimulus measures should be timely, targeted and temporary, and quickly reversed once conditions improve. It also states that stimulus can be hard to design, implement and later reverse.

The article addresses how much effect different measures have. It states that multipliers tend to be larger for spending measures than for tax cuts or transfers. A multiplier is the amount of economic output produced per unit of fiscal action, so the statement means that, per unit, spending measures tend to have the larger effect. The article also notes that targeting the poor carries a high likelihood of full spending and a strong economic effect.

The IMF article also states a limit on how far fiscal policy can go. It states that deficits that grow too large and linger risk undermining confidence.

Monetary Policy

The IMF pairs fiscal policy with monetary policy, so a short description of monetary policy follows. The IMF describes monetary policy as generally boiling down to adjusting the supply of money in the economy to achieve some combination of inflation and output stabilization. The St. Louis Fed describes it as actions that central banks take to pursue objectives such as price stability, maximum employment and stable economic growth.

For the United States, the Federal Reserve Board states that the Federal Reserve Act mandates that the Federal Reserve conduct monetary policy so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates. Decisions about monetary policy are made at meetings of the Federal Open Market Committee, known as the FOMC. The Board describes the federal funds rate as the FOMC's primary means of adjusting the stance of monetary policy.

The Federal Reserve's Fed Explained page describes the chain of effect. It states that the Fed changes the stance of monetary policy primarily by raising or lowering its target range for the federal funds rate. A change in the federal funds rate normally affects, and is accompanied by, changes in other interest rates and in financial conditions more broadly, and those changes then affect the spending decisions of households and businesses and thus have implications for economic activity, employment and inflation.

The Board describes two directions. Easing monetary policy lowers interest rates and stimulates overall demand. Tightening raises interest rates to guide economic activity back to more sustainable levels.

The FOMC's statement of longer-run goals states the inflation goal as inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures. It also states that the maximum level of employment is not directly measurable and changes over time. The statement carries the notation that it was adopted effective January 24, 2012, and amended effective August 22, 2025.

The Federal Reserve Board's policy tools page lists open market operations, the discount window, reserve requirements, interest on reserve balances, and overnight reverse repurchase agreement operations, along with other tools. The St. Louis Fed names open market operations, the discount rate, reserve requirements and interest on reserve balances among the key ones.

Fiscal Policy Compared With Monetary Policy

The two policies differ in who conducts them, what they use, and how they work.

On who conducts them, the sources agree. Congress and the administration conduct fiscal policy, and the Federal Reserve conducts monetary policy. The Richmond Fed lesson summarizes the tools: for fiscal policy, the spending, taxing and borrowing decisions of the federal government; for monetary policy, open market purchases or sales of government securities, loans to banks at a discount rate, and changes in depository institutions' reserve requirements.

On speed and reversibility, the IMF's monetary policy article draws the contrast. It states that fiscal policy, which it describes as taxing and spending, is an alternative tool but typically takes time to legislate and, once enacted, is politically difficult to reverse. It states that monetary policy can be implemented more rapidly and reversed more easily than many fiscal actions.

On how they interact, the Federal Reserve Board's FAQ states that fiscal policy has an indirect effect on the conduct of monetary policy through its influence on the aggregate economy.

Fiscal Policy and the SIE Exam

FINRA's Securities Industry Essentials examination content outline carries a 2024 copyright. It lists "Monetary vs. fiscal policy" under Section 1, Knowledge of Capital Markets, in function 1.3.1, which is titled The Federal Reserve Board's Impact on Business Activity and Market Stability. The same function lists open market activities and their impact on the economy, and different rates, such as the interest rate, the discount rate and the federal funds rate. Function 1.3.2, Business Economic Factors, lists the business cycle and economic indicators. A candidate should check FINRA's current outline for the version in force.

Common Misunderstandings

One misunderstanding is that the Federal Reserve conducts fiscal policy. The St. Louis Fed states that Congress and the administration conduct fiscal policy, while the Federal Reserve conducts monetary policy.

A second misunderstanding is that fiscal policy means only spending. The IMF's definition covers government spending and taxation, and the Richmond Fed lesson adds borrowing.

A third misunderstanding is that the deficit and the debt are the same thing. A deficit occurs when the money going out exceeds the money coming in for a given period, and the national debt is the total outstanding borrowing accumulated over the nation's history.

A fourth misunderstanding is that fiscal policy always requires a new decision. The IMF and the CBO describe automatic stabilizers, which change spending and revenue without any new government action or legislated change.

A fifth misunderstanding is that Congress votes on all federal spending every year. Fiscal Data states that mandatory spending is mandated by existing laws, while discretionary spending is approved during the appropriations process each year.

A sixth misunderstanding is that expansionary fiscal policy has no costs. The Richmond Fed lesson states that increasing federal spending or reducing taxes can put upward pressure on the price level and interest rates, and the IMF article states that deficits that grow too large and linger risk undermining confidence.

A seventh misunderstanding is that fiscal and monetary policy are two names for the same tool. Fiscal policy is government spending and taxation, conducted by Congress and the administration, while monetary policy is conducted by the Federal Reserve through tools such as the federal funds rate.

An eighth misunderstanding is that a tax cut and a spending increase of the same size have the same effect. The IMF article states that multipliers tend to be larger for spending measures than for tax cuts or transfers.

Key Points

Fiscal policy is the use of government spending and taxation to influence the economy, and in the United States it is conducted by Congress and the administration.

The federal fiscal year runs from October 1 to September 30, and the budget moves from agency requests, through the Office of Management and Budget and the President's proposal, to Congress and its funding bills.

Mandatory spending is set by existing laws, discretionary spending is approved in the annual appropriations process, and the government also pays interest on the debt.

A deficit is the shortfall for a period and is financed by selling Treasury securities, and the national debt is the accumulated borrowing along with the interest owed.

Expansionary fiscal policy increases aggregate demand and contractionary fiscal policy reduces it, and the Richmond Fed lesson describes employment, output, prices and interest rates as moving in different directions under each.

Automatic stabilizers are changes in tax revenues and spending that occur without new legislation as the economy moves through a cycle.

Monetary policy is conducted by the Federal Reserve, with decisions made by the FOMC and the federal funds rate as its primary means of adjusting the stance of policy, and the IMF states that monetary policy can be implemented more rapidly and reversed more easily than many fiscal actions.