What Is Fiscal Policy?
Fiscal Policy Definition
Fiscal policy refers to the governmental use of taxation and spending to influence the conditions of the economy.
Typically, fiscal policy comes into play during a recession or a period of inflation, where conditions are escalating quickly enough to warrant government intervention.
A good application of fiscal policy, in theory, should be able to stabilize a teetering economy and facilitate continued growth.
Fiscal Policy Purpose
The purpose of fiscal policy is to implement artificial measures to prevent an economic collapse and to promote healthy and steady economic growth.
Fiscal policies can be either expansionary or contractionary.
Expansionary policy, which is the more common of the two, is when the government responds to recession by lowering taxes and increasing government spending.
The principle at play is that when taxes are lowered, consumers have more money in their pockets to spend or invest, which increases the demand for products and securities.
Increasing demand for goods, as well as increased government spending, leads firms to hire more employees, lowering unemployment, as well as compete for employees more fiercely, which can increase wages.
This gives consumers yet more funds to spend, hopefully pulling the economy out of recession over time.
This is known as a virtuous cycle.
Contractionary policies are applied during a period of inflation.
During this the government may reduce spending on public projects or even reduce public-sector wages or the size of the workforce.
Contractionary policies are uncommon, though, because the preferred approach to reigning in rapid growth is to institute a monetary policy to increase the cost of borrowing.