Final answer:
The federal government's use of taxation and spending to stimulate the economy is known as fiscal policy. Fiscal policy can decrease taxes to increase consumer spending and can involve government spending on projects to boost economic activity, which may lead to a budget deficit and contribute to the national debt.
Step-by-step explanation:
Fiscal Policy and Economic Stimulation
When the federal government uses taxation and spending actions to stimulate the economy, it is conducting fiscal policy. Fiscal policy involves adjusting the levels of government spending and taxation to influence the economy. During times of recession, fiscal policy may involve decreasing taxation, which allows individuals to have more disposable income to spend, thereby stimulating consumer demand. Concurrently, the government might increase its own spending, for example, on infrastructure projects like road building, which directly injects money into the economy and can create jobs.
From a short-run perspective, fiscal policy aims to address economic challenges such as recession, unemployment, and inflation. When the government increases spending or decreases taxes to stimulate the economy, it often incurs a budget deficit, as it spends more than it collects in tax revenue. Over time, these deficits contribute to the national debt. Conversely, if the government spends less than it collects, it would lead to a budget surplus.
It is important to note that while all government taxation and spending can affect the economy, fiscal policy refers specifically to the federal government's use of these tools to manage economic conditions. The effectiveness of fiscal policy depends on various factors including the state of the economy, the timing and magnitude of government intervention, and the existing fiscal environment.