Fiscal policy

Fiscal policy is government spending and taxes that influence the economy. Elected officials should coordinate with monetary policy to create healthy economic growth. Fiscal policy reflects the priorities of individual legislators. These local needs prevail over a nation's economic priorities, and as a result, fiscal policy is hotly debated, whether at the federal, state, county, or municipal level.

Related topics

Monetary policy

What is fiscal policy?

It is the part of the policy that regulates and monitors the expenditures of the state economy and the way in which those expenditures are made. These expenditures are collected through taxes, which must also be monitored in order to fulfil their true function.

About fiscal policy

Fiscal policy consists of a series of activities that are focused on achieving political objectives. It is the use of power to try to resolve conflicts of the population and society. It also consists of a division of economic policy that is responsible for setting the budget enjoyed by the state through the imposition of taxes.

Characteristics

The main features of fiscal policy are as follows:

• It is a countercyclical
• It must use automatic stabilizers to adapt expenditure and revenue levels to the ups and downs of the economy.
• It encourages inclusion of the population.
• Provides better access to services such as education and health.
• Promotes the country’s growth.

Aims and objectives

The objectives of fiscal policy are to accelerate the economic growth of a country or society so that, there is full utilization of all the resources that society has, whether human, material or capital. In addition, it aims to bring price stability so that, prices do not suffer significant increases and decreases. It also monitors economic growth, amortizes changes in economy and ensures the proper use of all State resources.

Instruments

The instruments of fiscal policy are basically three aspects which include:

• Taxes: it is the main instrument of fiscal policy. When taxes increase or decrease, so does the money that consumers have to spend, generating a significant impact on overall economy. When taxes go down, the consumer can increase spending and this produces higher revenues for businesses, allows them to expand and in turn hire more workers.
• Government spending is the second most important instrument. Government spending promotes the economy and job creation. When public spending is high, it tends to promote employment and higher economic growth.
• Government deficit: when taxes are reduced and spending is increased you can promote economic growth, but when the government spends more than it needs through taxes, you create and run a deficit, that means you are losing money.

Types of fiscal policy

There are four different types of fiscal policy, which are detailed below:

• Expansive fiscal policy: this type of policy occurs in situations in which there is an economic decrease or when there are many stoppages, then the Government must apply an expansive fiscal policy in order to increase aggregate spending and increase effective income. It can be applied by reducing taxes, increasing government spending, stimulating private investment through tax breaks or exemptions.
• Contractive fiscal policy: when inflation occurs because of an excess of aggregate demand is when the contractive fiscal policy occurs. When this happens, it is necessary to apply restrictive fiscal policy to reduce aggregate expenditure. Taxes are increased and public spending is reduced.
• Restrictive fiscal policy: it happens when the net expenditure of the government is due to a greater fiscal collection or reduction of public expenditure or both which would result in a smaller or larger surplus than that previously planned by the government.
• Fiscal policy neutral: a balanced budget in which public expenditure equals fiscal revenue.

Importance of fiscal policy

Fiscal policy is considered to be the driving force behind state growth because it is the way in which both, economic and social development can be contributed to. It can be used to show employment levels, production levels and market prices. It is through fiscal policy that the budget that a State has with taxes and public expenditures is established, seeking to generate a balance for its citizens.

It is also very important when it comes to implementing redistributive policies or taxes. They are also a useful tool to reduce environmental pollution, this when a tax is charged for polluting the environment.

Examples

Some examples of fiscal policy are the following:

• Raise or Lower Taxes
• Increase VAT (aggregate sales tax)
• Increase export aliquots
• Distribute resources among the different levels of government (Nation, Province, Municipalities)
• Apply import restrictions