Fiscal Policy

Economics Tutorials

What is Fiscal Policy?

Fiscal policy is prepared to ensure economic growth of a country. The government of a country takes responsibility for the well-being of the countrymen. That’s why every spending of the government should be in the right order. And to do so, the government needs to collect the taxes from businesses and individuals of the country.

Monetary policy is part of the fiscal policy. And once the policy is in the right order, the monetary policy takes the right shape. Also, have a look at Monetary Policy vs Fiscal Policy

Though the actual purpose of the fiscal policies are argued among the ministers of the country, in essence, the objective of a fiscal policy is to take care of the local needs of the country so that the national interest can be kept as an overall goal.

As we note from the above snapshot, China reassures that its fiscal policy is still expansionary despite fiscal deficit cut. What do we mean by this? Let us first understand the types of fiscal policies.

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Two Types of Fiscal Policy

There are two types of fiscal policies. Both of these policies work well for the overall growth of the economy. But the government use one of them at times when one is required more than the other.

Let’s talk about both of these.

#1 – Expansionary Fiscal Policy:

This policy is quite popular among the people of the country because through this, consumers get more money in their hands and as a result their purchasing power increases drastically. The government uses this by two ways. Either they spend more money on public works, provide benefits to the unemployed, spend more on projects that are halted in between or they cut taxes so that the individuals or businesses don’t need to pay much to the government. You may think which one is more prudent! People who favour the government spending prefer it over cutting taxes because they believe that if the government spends more, the unfinished projects would be completed. On the other hand, individuals who prefer cutting taxes talk about it because they believe that by cutting taxes the government would be able to generate more cash into consumers’ hands. Expansionary policy isn’t easy to apply for state government because state government is always on a pressure to keep a budget that is balanced. As it becomes impossible at local levels, expansionary fiscal policy should be mandated from the central government.

#2 – Contractionary Fiscal Policy:

As you can expect, a contractionary fiscal policy is just the opposite of the expansionary fiscal policy. That means the objective of the contractionary policy is to slow down the economic growth. But why a government of a country would like to do that? The only reason for which contractionary fiscal policy can be used is to flush out the inflation. However, it is a rarest thing and that’s why government doesn’t use contractionary policy at all. The nature of this sort of policy is just the opposite. In this case, the government spending is cut as much as possible and the rate of taxes is increased so that the purchasing power of the consumer gets reduced. Taking away money from the hands of the consumers can be dangerous because that means businesses will not be able to sell off goods and services and as a result, the economy will take a sure-shot hit which only can be reversed by taking the expansionary fiscal policy.

Fiscal surplus and fiscal deficit

Fiscal surplus and fiscal deficit are two important concepts of this policy. The idea behind these two concepts is simple.

First, let’s talk about fiscal surplus and then we will define fiscal deficit.

Fiscal surplus

When the government spends less than it earns, then the government creates a fiscal surplus. This concept sounds great, but normally it’s very difficult to create a surplus in reality.

Fiscal deficit

When the government spends more money than it earns, then it is called a fiscal deficit. This concept is very much known to the public because the media and newspapers talk a lot about it. When a government creates a fiscal deficit, it needs to take the debt from external sources and then bear the cost (if any). Fiscal deficit, as you can expect, is much more common phenomenon than fiscal surplus.

Two Primary Tools of fiscal policy

The main tools of fiscal policy of any government are two. Let’s have a look at them –

#1 – Taxes

This is the main tool through which the government collects money from the public. The government collects money from the public through income taxes, sales taxes, and other indirect taxes. Without taxes, a government would have very little room to collect money from the public.

#2 – Government spending

To ensure economic growth, the government needs to spend money on projects that matter. The projects can be creating a subsidiary, paying the unemployed, pursuing projects that are halted in between etc.