Fiscal policy

Fiscal policy is the means by which a government influences a nation’s economy by varying the level of public spending and taxation. Together with monetary policy, it is used to direct a country towards its economic goals (such as a target growth rate, inflation rate, etc.).

For example, a government wishing to boost growth and lower unemployment will increase government spending and/or reduce tax. When individuals and companies have less tax to pay, they have more disposable money to spend on goods and services. As a result, jobs are created and therefore spending power is increased.

On the other hand, a government wishing to moderate inflation by cooling aggregate activity in the economy can do so by reducing government spending and/or increasing taxes.

The key is to find the right balance in exercising the influence of fiscal policy together with monetary policy, due to the various tradeoffs in an economy (for example, lower unemployment tends to be associated with higher inflation).