Fiscal policy
Fiscal policy refers to the government's use of taxation and spending to influence the economy,
aiming to achieve macroeconomic goals like economic growth, employment, and price stability
Tools
Fiscal policy uses two main tools:. These tools can either be used to stimulate the economy
(expansionary fiscal policy) or slow down the economy (contractionary fiscal policy)
● Government Spending: This includes public expenditure on goods and services,
such as infrastructure projects, healthcare, education, defense, etc. When the
government increases its spending, it stimulates demand in the economy.
Conversely, reducing government spending can slow down an overheated economy.
● Taxation: Changes in taxes affect the disposable income of households and
businesses, influencing their spending behavior. For example, lowering taxes
increases the disposable income of individuals and encourages spending and
investment, while raising taxes can reduce aggregate demand and cool down
inflationary pressures.
Types of fiscal policy
● Expansionary Fiscal Policy
Think of this as the government hitting the accelerator when the economy is slowing down.
When businesses struggle, unemployment rises, or demand weakens, the government steps
in by spending more—on things like roads, schools, and healthcare. At the same time, it
lowers taxes, so people and businesses have more money to spend. This extra spending
fuels demand, encouraging companies to expand and hire more workers. However, if used
too much, it can lead to high inflation or growing national debt.
● Contractionary Fiscal Policy
This is like pressing the brakes when the economy is overheating. When inflation gets out of
control, the government spends less and raises taxes, pulling money out of circulation.
With people and businesses having less to spend, demand slows down, and prices stabilize.
While this helps control inflation, using it too aggressively can slow down economic growth
and increase unemployment.
Impact of fiscal policy on the economy
● Economic Growth – Increased government spending and lower taxes boost
demand, encouraging businesses to expand and create jobs.
● Inflation Control – Higher taxes and reduced spending help slow down excessive
demand, keeping inflation in check.
● Employment Levels – Expansionary policies create more job opportunities, while
contractionary policies may slow hiring but prevent economic overheating.
● Government Debt – More spending can lead to higher debt, while cutting spending
and increasing taxes help reduce it.
● Public Services & Infrastructure – Well-planned fiscal policies improve roads,
schools, and healthcare, directly benefiting people’s lives.
● Investor Confidence – A stable fiscal policy reassures businesses and investors,
leading to more investment and economic stability.
