What is Fiscal Policy

This article explains what fiscal policy is.

A government’s fiscal policy is defined as the choices it makes regarding taxation, spending, and other financial operations in order to achieve specific national objectives.

1. What is Fiscal Policy?

A government’s fiscal policy is defined as the choices it makes regarding taxation, spending, and other financial operations in order to achieve specific national objectives.

Using its spending and taxation programs, the government aims to boost economic growth, employment, and revenue by reducing or eliminating negative effects. A long-term stable economy can only be maintained by controlling short-term fluctuations in the economy. As a result, fiscal policy aims to accomplish the following:

  • Achieving and maintaining full employment is an important goal in any employment policy.
  • Stabilizing or preserving the economy’s growth rate.
  • Achieving a steady state of market prices.
  • Assisting in the progress of economically disadvantaged nations.
  • Maintaining a balance in the country’s foreign exchange reserves.
  • Fairness and equality in the economic sphere.

2. What is the Process of Fiscal Policy?

The theories of British economist John Maynard Keynes underpin fiscal policy. This theory, also known as Keynesian economics, states that governments can influence macroeconomic productivity levels by altering tax rates and public spending.

This influence, in turn, reduces inflation (which is generally considered to be healthy when it is between 2% and 3%), boosts employment, and keeps money at a healthy value. Fiscal policy is crucial in the management of a country’s economy.

In 2012, for example, many people were concerned that the fiscal cliff, which would result in a simultaneous increase in tax rates and reductions in government spending in January 2013, would send the US economy back into recession.

On January 1, 2013, the United States Congress passed the American Taxpayer Relief Act of 2012, which avoided this problem1. 

3. Explanation

The economy is affected by changes in government spending and taxation. As an example, when the government increases public spending during the depression, the aggregate demand for goods and services rises, resulting in an increase in income.

As personal disposable income rises as a result of lower taxes, people are more likely to spend and invest their money.

With regard to inflation control, if the government decides to reduce the public expenditure, the aggregate demand decreases as a result of a decrease in employment, production, output, and prices, all of which are affected.

As taxes are lowered, less money is available for consumption and investment, which means less money is available to spend. Consequently, the government’s expenditure and taxation programmes can be used effectively to combat inflationary and deflationary pressures in the economy.

When the government’s revenue exceeds its expenditure, fiscal policy is considered tight or contractionary, i.e. the government budget is in surplus. When the government’s spending exceeds its revenue, it is said to have an expansionary or loose policy, resulting in a budget deficit.

Fiscal policy, on the other hand, is not concerned with the current level of deficit, but rather with the change in deficit. Even if the budget is still in deficit, reducing a deficit from Rs 2 million to Rs 1.5 million is considered a contractionary fiscal policy.

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  1. H.R.8 – 112th Congress (2011-2012): American Taxpayer Relief Act of 2012 | Congress.gov | Library of Congress. (n.d.). Retrieved February 21, 2022, from https://www.congress.gov/bill/112th-congress/house-bill/8
  2. What Is Fiscal Policy? How It’s Used & The Effects. (n.d.). Retrieved February 21, 2022, from https://www.investopedia.com/insights/what-is-fiscal-policy/#citation-1
  3. What is Fiscal Policy? definition and meaning – Business Jargons. (n.d.). Retrieved February 21, 2022, from https://businessjargons.com/fiscal-policy.html

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