Approaches to the Study of Fiscal Policy (Pols 220)

Introduction 

Fiscal policy—government's use of spending and taxation to influence the economy—has been studied through several theoretical lenses, each offering a different view on how active government intervention should be. Two foundational approaches are examined below: the Keynesian (classical) approach and the Neo-classical approach.

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1. Classical / Keynesian Approach

Advocates of this approach proposed what they called Counter-Cyclical fiscal policies—meaning implementing an expansionary fiscal policy during a recession and a contractionary fiscal policy during rapid economic expansion. Keynesian economists argued that private sector decisions sometimes lead to inefficient macroeconomic outcomes, which require active responses by the public sector to stabilize output over the business cycle.

Counter-cyclical fiscal policies are policies that act against the tide of the business cycle—this means deficit spending and decreased taxes when the economy suffers a recession. Furthermore, if the economy is producing less than its potential output, government spending can be used to employ idle resources and boost output. Increased government spending results in increased aggregate demand, which in turn increases real GDP.

2. Neo-Classical Approach

The Neo-classicals believe in a more passive fiscal policy approach, designed to promote economic growth with stable prices. They favor low tax rates and limited government spending, allowing greater private sector participation. According to this approach, government should focus more on long-term growth and controlling inflation than on worrying about recession or cyclical unemployment.

Conclusion

These two approaches represent opposite poles on the role of government in managing the economy: the Keynesian view calls for active, cycle-responsive intervention, while the Neo-classical view favors restraint, price stability, and reliance on market mechanisms for long-run growth. Later frameworks—such as the Monetarist and New Classical approaches—largely built on the Neo-classical skepticism of discretionary fiscal intervention.