Fiscal Policy

    - Advertisement -

    Fiscal policy involves the government changing the levels of taxation and government spending in order to influence Aggregate Demand (AD) and the level of economic activity. AD is the total level of planned expenditure in an economy.

    Purpose of Fiscal Policy

    • Stimulate economic growth in a period of a recession.
    • Keep inflation low (UK government has a target of 2%)
    • Basically, fiscal policy aims to stabilize economic growth, avoiding a boom and bust economic cycle.

    Fiscal policy is often used in conjunction with Monetary Policy. In fact, governments often prefer monetary policy for stabilizing the economy.

    Must Read: Economics: The Basics 

    Types of Fiscal Policy

    There are two basic types of fiscal policy. The first, and most widely-used, is expansionary. Its objective is to stimulate the economy and create more growth. This is most critical at the contraction phase of the business cycle when voters are clamoring for relief from a recession.

    - Advertisement -

    The government spends more, or cuts taxes or both if it can. The idea is to put more money into consumers’ hands, so they spend more. This jumpstarts demand, which keeps businesses running,

    Expansionary fiscal policy is usually impossible for state and local government because they often are mandated to keep a balanced budget. If they haven’t created a surplus during the boom times, they usually have to cut spending to match lower tax revenue during a recession — making it worse.

    The second type, contractionary fiscal policy, is rarely used. That’s because its objective is to slow economic growth. One reason only, and that’s to stamp out inflation. That’s because the long-term impact of inflation can damage the standard of living as much as a recession.

    The tools of contractionary fiscal policy are used in reverse: taxes are increased, and spending is cut. Monetary policy is very effective in preventing inflation.

    Also Read: Elements of Economics

    Tools of Fiscal Policy

    The first tool is taxation, whether of income, capital gains from investments, property, sales or just about anything else. Taxes provide the major revenue source that funds the government. The downside of taxes is that whatever or whoever is taxed has less income to spend themselves. That makes taxes very unpopular.

    The second tool is spending. The government provides subsidies, transfer payments including welfare programs, contracts to perform all kinds of public works, and of course salaries to government employees — to name just a few. The reason government spending is a tool is that whatever or whoever receives the funds has more money to spend, thus driving demand and economic growth.

    Have a Look at: History of Money

    Fiscal Policy vs. Monetary Policy

    Monetary policy is when a nation’s central bank increases the money supply, using expansionary monetary policy, or decreases it, using contractionary monetary policy. It has many tools it can use, but it primarily relies on raising or lowering the Fed funds rate. This benchmark rates then guides all interest rates. When interest rates are high, the money supply contracts, the economy cools down, and inflation is prevented. When interest rates are low, the money supply expands the economy heats up, and a recession is avoided — usually.

    Monetary policy works faster than fiscal policy. The Fed can simply vote to raise or lower rates at its regularly FOMC meeting. It may take about six months for the effect to percolate throughout the economy.

    Don’t Miss: Foreign Trade Policy (FTP) 2015 – 20

    Brief history of fiscal policy

    • Keynes advocated the use of fiscal policy as a way to stimulate economies during the great depression.
    • Fiscal Policy was particularly used in the 50s and 60s to stabilize economic cycles. These policies were broadly referred to as ‘Keynesian’
    • In the 1970s and 80s governments tended to prefer monetary policy for influencing the economy. Fiscal policy became more prominent during the great depression of 2008-13.

    Must Read:

    India’s Trade Policy

    Defense Procurement Policy (DPP) 2016

    Indian economy

    - Advertisement -

    Recent Articles

    Current Affairs Daily

    Today's Current Affairs and General Knowledge Current Affairs Daily Digest is a collection of important current...

    Bombay Stock Exchange (BSE) of India

    The oldest stock market in Asia, BSE stands for Bombay Stock Exchange and was initially known as "The Native Share and Shock Brokers Association"....

    Transportation in India: India transport sector

    India’s Transport Sector, as it caters to the need of nearly 1.1 billion people, is large and diverse. A smooth and co-ordinated...

    Biography of Mahatma Gandhi – A Journey from Mohandas to Mahatma

    On the evening of 30th January, 1948, at his daily prayer meeting Gandhiji was shot dead by a young man from Pune named Nathuram...

    Early Entrepreneurs of India

    The first cotton mill in Bombay came up in 1854 and it went into production two years later. By 1862, four...

    Related Stories

    Stay on op - Ge the daily news in your inbox