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Before the 1930s when Keynes came on to the scene, it was argued that the economy should be left alone as much as possible. The government should adopt a 'laissez-faire' approach. Keynes argued that the government should adopt discretionary fiscal policy to solve economic problems like unemployment.

Fiscal policy is the deliberate manipulation of government spending and taxation to achieve the government's economic policy objectives.

In times of high unemployment a deflationary gap exists. The government could close the deflationary gap by increasing government spending, reducing taxation (which will reduce consumption) or a combination of the two. This increase in planned expenditure will cause a multiple expansion of national income until the deflationary gap is eradicated. Increasing government spending or reducing taxes will probably lead to a budget deficit. The budget is in balance when government spending is equal to government revenue. If the government runs a budget deficit, then it will have to borrow money - leading to a Public Sector Borrowing Requirement (PSBR). Keynes argued that running a budget deficit was a small price to pay for the achievement of full employment.

If an economy was in an inflationary gap, then Keynes argued that fiscal policy should be used to eradicate this inflationary gap. This would involve raising taxes or cutting government spending. Since government spending was usually long term and often had socially desirable aspects, it was felt that raising taxes was the most appropriate way of removing an inflationary gap. If such measures led to government revenues exceeding government spending, then a budget surplus would arise. When a government is running a budget surplus it can pay off some of its accumulated debt. This means there will be Public Sector Debt Repayment (PSDR) rather than a PSBR.

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