Fiscal policy

Fiscal policy

Fiscal Policy


  • Fiscal policy is the government’s strategy to adjust its levels of spending and taxation to monitor and influence a nation’s economy.

Tools of Fiscal Policy

  • Government spending: This involves expenditures on public goods and services, welfare, infrastructure, education, and healthcare.
  • Taxation: This includes income tax, corporation tax, capital gains tax, and value-added tax. Lower taxes can increase disposable income and stimulate demand; higher taxes can reduce inflation.

Expansionary and Contractionary Fiscal Policy

  • Expansionary fiscal policy is used to stimulate the economy during a recession. It generally involves government spending increases, tax reductions, or both.
  • Contractionary fiscal policy is used to cool down the economy during an overheating expansion or a period of high inflation. It involves reducing government spending, raising taxes, or both.

Impact on Aggregate Demand

  • Fiscal policy directly impacts the components of aggregate demand (consumption, investment, and government spending).
  • Cutting taxes can increase disposable income, boosting consumption. Similarly, increasing public spending can increase overall demand.

Fiscal Policy and Economic Growth

  • Effective fiscal policy can stimulate economic growth in the short run by increasing demand.
  • In the long run, fiscal policy could aid growth by funding public investments that increase the economy’s productive capacity.

Fiscal Multiplier

  • The fiscal multiplier is the change in national income that results from a change in government spending or taxation.
  • The multiplier effect kicks in when increased spending causes further spending and additional economic activity.

Fiscal Policy Limitations

  • Implementation delay: It can take time for the effects of fiscal policy adjustments to filter through the economy.
  • Political challenges: Decisions on fiscal policy are often influenced by politics, which can lead to sub-optimal economic decisions.
  • Crowding out: Increased government spending may lead to private sector investment being suppressed.

Importance of Fiscal Policy

  • Fiscal policy plays a key role in stabilising the national economy and maintaining full employment.
  • It is an essential part of managing public finances and ensuring sustainable economic growth.