Fiscal Policy

Published Jan 8, 2023

Definition of Fiscal Policy

Fiscal policy is the use of government spending and taxation to influence the economy. That means it is a tool used by governments to manage the level of economic activity in the country. It is usually used to achieve macroeconomic objectives such as full employment, price stability, economic growth, and a balanced budget.

Example

To illustrate how fiscal policy works, let’s look at an example. Assume the government wants to stimulate the economy and increase economic growth. To achieve this, it can increase government spending on infrastructure projects, such as building roads and bridges. This will create jobs and increase demand for goods and services. At the same time, the government can reduce taxes to put more money in the pockets of consumers, which will further stimulate economic activity.

By contrast, if the government wants to slow the economy down, it can reduce its own spending and increase tax rates. Doing so decreases economic activity because there is less work, and people have to pay a higher share of their income in taxes, which means they cannot use it for consumption.

Why Fiscal Policy Matters

Fiscal policy is an important tool for governments to manage the economy. It can be used to achieve a variety of macroeconomic objectives, such as full employment, price stability, economic growth, and a balanced budget.

By using fiscal policy, governments can influence the level of economic activity in the country and ensure that the economy is running smoothly. In addition to that, this type of policy can also be used to reduce inequality and poverty, as well as to promote social welfare. Thus, it is closely related to monetary policy, which describes the tools, central banks have to influence the economy.