What is Fiscal Policy?

The flow of tax revenue and public spending to steer the economy is done by a government through its fiscal policy. The government runs a surplus if it collects more money than it spends, and a deficit the spending is more than the collection in taxes and other revenue. The government must borrow money either locally or internationally to cover extra costs. The government also has the option of issuing more currency or using its foreign exchange reserves. For instance, during a recession, the government may decide to increase spending on financial incentives to businesses, construction projects, welfare programmes, and more.

This is done to urge businesses to invest and make productive money accessible to the public. The government might also choose to impose taxes on individuals as well as companies slightly less at the same time.

Objectives of Fiscal Policy 

The objectives of the fiscal policy are as follows:

1. Fiscal policy aids in maintaining the growth of the economy in order to achieve economic objectives.

1. Another goal of the fiscal policy is increasing employment to help the economy recover from a period of low economic activity.
2. It maintains the country’s price level by controlling the rates during inflation.
3. The fiscal policy imposes direct taxes on those with higher incomes and subsidises the consumption goods of low-income families.
4. It subsidises food, fuel, and other necessities and levies indirect taxes on luxury goods such as imported cars and cosmetics, thereby, promoting social equality.

Types of Fiscal Policy 

The various types of fiscal policies are listed below

Expansionary Fiscal Policy

The decisions that the governments have taken to raise their monetary contributions to the country's economy are included in an expansionary fiscal policy. This policy is responsible for generating a huge number of goods and services. It also increases employment opportunities and boosts personal and governmental profits.

Contractionary Fiscal Policy

This type of fiscal policy is used when the economy is booming. However, rapid growth in the country’s economy can pose a risk. In this case, the government takes steps to stop the ongoing economic boom. This additionally contributes to controlling both inflation and economic growth.

Neutral Fiscal Policy

The government uses a neutral fiscal policy when the economy of the country is balanced. It indicates that things are progressing well given the economic highs and lows. A neutral fiscal policy includes government expenditure that is financed by taxes imposed on individuals, companies, or various sectors of the economy. It does not influence the condition of the country's economy.

Fiscal Policy vs Monetary Policy

The key differences between a fiscal policy and a monetary policy are highlighted in the table below:

How Does Fiscal Policy Work

The fiscal policy is impacted by two factors used by the government:

1. Government expenditure: It is the method by which the government makes investments in social welfare programmes and other public infrastructure projects that either directly or indirectly affect the overall condition of the economy.
2. Taxation: It is the process by which the government raises or lowers the amount of disposable money in the possession of the general public.

When the economy is experiencing high inflation, the government can propose new taxes or increase the rates of existing taxes in order to encourage spending. Negative growth in the economy could lead to decreased demand and production. To combat this, the government could raise spending in order to offset the decline in private-sector investment and stimulate the market.