Fiscal Policy



Fiscal policy describes the measures governments take in an attempt to influence the economy. Most commonly they are used to boost or encourage economic growth by cutting taxes and increasing government spending. Sometimes, governments will do the opposite and try to restrict economic growth and inflation. These policies are subject to political pressures more than monetary policies are, and they have important implications with respect to the national debt and budget deficits.

At A Glance

  • Changes in government spending and tax rates are used to shift aggregate demand to achieve desirable policy outcomes.
  • Governments pursue an expansionary fiscal policy to increase aggregate demand (usually via deficit spending) when they want to make the economy grow.
  • Governments pursue a contractionary fiscal policy to decrease aggregate demand when they want to slow economic growth.
  • Fiscal policy is highly susceptible to political and ideological influence because it is set by governments and elected officials.
  • Government spending leads to an increase in the interest rate, which can diminish aggregate demand in a process known as crowding out.
  • Expansionary fiscal policy has a major effect on government deficits and debt, which, in turn, have serious implications for the wider economy as a whole.