Fiscal Policy

While the Federal Reserve controls monetary policy, Congress and the President control fiscal policy—decisions about government taxation and spending. Investment advisers must understand how fiscal policy affects economic conditions and securities markets.

What Is Fiscal Policy?

Fiscal policy involves government decisions about:

• Taxation — How much revenue the government collects from individuals and businesses
• Government Spending — How much the government spends on programs, services, and infrastructure

Unlike monetary policy (controlled by the independent Fed), fiscal policy is inherently political—it requires Congressional action and Presidential approval.

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Components of Fiscal Policy

Government Spending

Government spending injects money directly into the economy through:

Taxation

Taxation removes money from the private economy:

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Types of Fiscal Policy

Expansionary Fiscal Policy

Expansionary fiscal policy is used to stimulate a sluggish economy:

Example: The 2020-2021 COVID-19 relief packages totaling over $5 trillion combined increased spending (stimulus checks, enhanced unemployment) with tax relief to combat the pandemic recession.

Contractionary Fiscal Policy

Contractionary fiscal policy is used to slow an overheating economy:

Contractionary fiscal policy is politically unpopular and rarely used deliberately. More often, governments reduce the pace of spending growth or let tax cuts expire.

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Fiscal Policy vs. Monetary Policy

Investment advisers must understand how these two policy types differ and interact:

How They Work Together

During recessions, both policies are often expansionary:

• Fed: Lowers rates, buys securities
• Congress: Increases spending, cuts taxes

During overheating economies:

• Fed: Raises rates, sells securities (contractionary)
• Congress: May reduce spending or raise taxes (though politically difficult)

Sometimes they work at cross-purposes (e.g., Fed tightening while Congress spending heavily), which creates policy uncertainty.

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The Multiplier Effect

Government spending can have a multiplied effect on economic activity:

How It Works:

1. Government spends $1 million on infrastructure
2. Construction workers receive wages
3. Workers spend on groceries, housing, entertainment
4. Those businesses pay their workers
5. Those workers spend again

Result: That initial $1 million generates more than $1 million of economic activity.

The multiplier effect depends on the marginal propensity to consume (MPC)—how much of each additional dollar people spend rather than save. Higher MPC = larger multiplier.

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Budget Concepts

Budget Deficit vs. Surplus

National Debt vs. Annual Deficit

These terms are often confused:

Analogy: The deficit is like your annual credit card bill; the national debt is your total outstanding balance.

Debt Ceiling

The debt ceiling is a legal limit on how much the federal government can borrow. Congress must vote to raise it periodically, which often becomes politically contentious.

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Impact on Investments

Fiscal policy affects securities markets through several channels:

Stocks

Bonds

Specific Sectors

Fiscal policy directly affects some sectors more than others:

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In Practice: How Investment Advisers Apply This

Monitoring fiscal policy changes:

• Tax reform can affect after-tax investment returns
• Changes to capital gains rates affect selling decisions
• Estate tax changes affect wealth transfer planning
• Infrastructure bills may benefit specific sectors

Client conversations:

• Help clients understand that fiscal stimulus may lead to future tax increases or inflation
• Discuss how budget deficits may eventually affect interest rates
• Consider tax-advantaged investments when tax rates rise

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On the Exam

The Series 65 exam tests your understanding of:

1. Difference between fiscal and monetary policy
2. Expansionary vs. contractionary fiscal policy
3. Deficit vs. debt — annual shortfall vs. cumulative total
4. Impact on securities markets
5. Who controls fiscal policy (Congress and President, not the Fed)

Common question format: "Which of the following is an example of expansionary fiscal policy?"

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Key Takeaways

• Fiscal policy involves government taxation and spending decisions
• Controlled by Congress and the President (not the Federal Reserve)
• Expansionary policy: Increase spending and/or cut taxes (creates deficits)
• Contractionary policy: Decrease spending and/or raise taxes (creates surpluses)
• Budget deficit = one year's shortfall; national debt = cumulative total
• Fiscal policy works more slowly than monetary policy due to the legislative process
• The multiplier effect means government spending can generate more than $1 of activity per $1 spent
• Investment advisers should monitor fiscal policy for sector and tax implications