Fiscal Policy
Fiscal policy refers to the budgetary policy of the government, which involves the government controlling its level of spending and tax rates within the economy.
Generally, governments have two tools at hand to organise the economy – fiscal policy and monetary policy. While fiscal policy relies on taxation, government spending and government borrowing, monetary policy focuses primarily on adjusting money supply or interest rates to manage business cycle phenomena, such as recessions.
The government has two tools of fiscal policy. Depending on how the government decides to use these instruments, it is possible to learn about the state of the economy.
- Taxes
- Government spending
While fiscal policy lies within the competence of the government, monetary policy is conventionally a responsibility of the central bank. What are the types of fiscal policies?
- Neutral fiscal policy – this policy is used when the economy is neither in recession or expansion. It means that the government has an average amount of deficit spending.
- Expansionary fiscal policy – this policy is used when trying to balance the contraction phase in the business cycle, meaning that the government is attempting to compensate for the fallout in the private sector. Under these circumstances, the government increases its spending, meaning that the budget deficit exceeds tax revenue by more than it usually does. This additional spending is commonly targeted to undertake public projects (building public infrastructure etc.) or by cutting taxes.
- Contractionary fiscal policy – this policy is used to cool down the economy, for example, in an environment of inflation. It occurs when government deficit spending is lower than usual and it can take place either by increasing taxes or decreasing government spending.
