Fiscal Policy

Deficit

A fiscal deficit is often funded by issuing secure bonds such as treasury bills. These pay interest, either for a fixed period or indefinitely. The nation may default on its debt if the interest and capital repayments are too large. This is how a Government funds the deficit.

Surplus

A fiscal surplus is usually saved for future use, and may be invested in local instruments, till needed. When income from taxation or other sources falls, usually during an economic crash, reserves allow Government spending to continue at the same rate, without gaining additional liabilities.

Economic Effects of Fiscal Policy

Fiscal policy is used by governments to influence the level of aggregate demand in the economy, in an effort to achieve economic objectives of stability in the price of goods, employment and the economic growth of the country. Keynesian (John Maynard Keynes) economics suggests that increasing or decreasing the Government spending and the tax rates to stimulate aggregate demand as a favorable outcome. This is usually used in times of recession or low economic activity as an essential tool in providing the framework for strong economic growth and working toward full employment. The Government usually implements such deficit-spending policies due to its size and reputation and stimulates trade. In theory, these deficits would be paid for by an expanded economy during the boom that would follow.
During high economic growth periods, budget surplus is usually used to decrease activity in the economy. A budget surplus will be implemented in the economy if inflation is high, in order to achieve the objective of price stability. According to Keynesian theory, the removal of funds from the economy will reduce levels of aggregate demand in the economy and contract it that will bring stability in the price level.