Stances of fiscal policy

The three possible stances of fiscal policy are neutral, expansionary and contractionary. The simplest definitions of these stances are as follows:

• A neutral stance of fiscal policy implies a balanced economy. Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity.

• An expansionary stance of fiscal policy involves government spending exceeding tax revenue.

• A contractionary fiscal policy occurs when government spending is lower than tax revenue.

However, these definitions can be misleading because, even with no changes in spending or tax laws at all, cyclical fluctuations of the economy cause cyclical fluctuations of tax revenues and of some types of government spending, altering the deficit situation; these are not considered to be policy changes. Therefore, for purposes of the above definitions, "government spending" and "tax revenue" are normally replaced by "cyclically adjusted government spending" and "cyclically adjusted tax revenue". Thus, for example, a government budget that is balanced over the course of the business cycle is considered to represent a neutral fiscal policy stance.