Introduction
Fiscal policy refers to how a government manages its spending and taxation to influence the economy. Essentially, it is a way for the government to regulate economic growth, stabilise prices, and reduce unemployment. Fiscal policy plays a crucial role in shaping the economic landscape by using the government’s power to adjust how much it spends and how much it collects in taxes.
Fiscal policy can be either expansionary or contractionary.
Expansionary Fiscal Policy
When a government wants to boost economic activity, it adopts expansionary fiscal policy by increasing public spending or cutting taxes. This type of policy is typically used during periods of economic recession or slowdown, when demand in the economy is weak, and unemployment is high. By increasing government spending on infrastructure projects or reducing income taxes, more money is put into the hands of consumers and businesses. This stimulates demand, leads to job creation, and encourages overall economic growth. Expansionary fiscal policy aims to kick-start economic activity and reduce unemployment.
Contractionary Fiscal Policy
On the other hand, contractionary fiscal policy is used when the economy is growing too quickly, which can lead to inflation. Inflation occurs when the general price level of goods and services rises, reducing the purchasing power of money. To prevent the economy from overheating, the government may implement contractionary fiscal measures such as decreasing public spending or increasing taxes. By doing so, the government reduces the amount of money circulating in the economy, which helps to lower demand and stabilise prices. Contractionary fiscal policy aims to maintain economic stability by preventing excessive inflation.
How Does Fiscal Policy Differ from Monetary Policy?
While fiscal policy involves decisions about government spending and taxes, monetary policy is managed by a country’s central bank, like the Bank of England or the Federal Reserve in the US. Monetary policy mainly revolves around controlling interest rates and the money supply to influence economic stability and growth.
Fiscal policy and monetary policy are both essential tools for managing the economy, but they differ in approach and implementation. Fiscal policy is carried out by the government, whereas monetary policy is the domain of the central bank. For a deeper understanding of monetary policy and how it works, check out our article here: What is Monetary Policy?
Why Fiscal Policy Matters
Fiscal policy is a critical tool in a government’s economic strategy. It impacts how much money people have in their pockets, the number of jobs available, and the overall stability of the economy. The right balance of public spending and taxation can mean the difference between economic growth and stagnation.
Ultimately, fiscal policy is about finding that balance—spending enough to keep the economy active while not overextending in ways that could lead to high debt or inflation. It is a continuous balancing act that helps keep an economy healthy and responsive to changing conditions.
Image Source: By U.S. Embassy in U.K. – https://www.flickr.com/photos/usembassylondon/36560214560/, Public Domain, https://commons.wikimedia.org/w/index.php?curid=89890272
