What's the relationship between fiscal policy and national debt?

Fiscal policy directly influences national debt as government spending and taxation decisions impact the level of public borrowing.

Fiscal policy refers to the use of government spending and taxation to influence the economy. When the government spends more than it collects in taxes, it creates a budget deficit. This deficit is financed by borrowing, which increases the national debt. Conversely, if the government collects more in taxes than it spends, it creates a budget surplus, which can be used to pay down the national debt.

The relationship between fiscal policy and national debt is therefore a balancing act. On one hand, expansionary fiscal policy, which involves increasing government spending or reducing taxes, can stimulate economic growth. However, it also increases the budget deficit and, consequently, the national debt. On the other hand, contractionary fiscal policy, which involves reducing government spending or increasing taxes, can slow economic growth but reduce the budget deficit and national debt.

The impact of fiscal policy on national debt also depends on the state of the economy. In times of economic downturn, governments often adopt expansionary fiscal policies to stimulate growth, even though this increases the national debt. This is based on the Keynesian theory that increased government spending during a recession can help to kick-start the economy. However, once the economy recovers, governments should switch to contractionary fiscal policies to reduce the debt accumulated during the downturn.

In the long term, high levels of national debt can have negative effects on the economy. It can lead to higher interest rates, as lenders demand higher returns to compensate for the increased risk of lending to a heavily indebted government. This can crowd out private investment, as higher interest rates make borrowing more expensive for businesses and households. High national debt can also lead to inflation if the government resorts to printing money to pay off its debts.

In conclusion, fiscal policy and national debt are closely intertwined. The decisions governments make about spending and taxation not only influence economic activity but also the level of national debt. Therefore, policymakers must carefully consider the potential impacts of their fiscal policy decisions on national debt.