Definition of Fiscal Policy
Fiscal policy is primarily based on the theories of John Maynard Keynes (1883-1946), the
British economist, who concluded that economic recessions are due to a shortfall in the
components of aggregate demand for consumption spending and business investment.
Keynes believed that by changing expenditure and tax policies to compensate for the private
sector's shortfalls, policymakers could stabilize the business cycle and control economic
production. In response to the Great Depression, which defied the assumptions of classical
economics that economic swings were self-correcting, his theories were established. The
proposals of Keynes were highly influential and contributed to the U.S. New Deal, which
included substantial spending on public works projects and services for social welfare.
Aggregate demand or spending is what determines the efficiency and development of the
economy in Keynesian economics. Consumer spending, company expenditure spending, net
government spending, and net exports are made up of aggregate demand.