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What Is the Role of Fiscal Policy?

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  • Written By: Paul Cartmell
  • Edited By: E. E. Hubbard
  • Last Modified Date: 03 September 2016
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The role of fiscal policy is to provide growth and stability to the economy of a nation or region of the world through government intervention in taxation and the adjustment of government expenditure. Fiscal policy has often taken a central role in the economy of a country when an economic downturn occurs and the government feels that stabilization is required. Long-term fiscal policy aims include the reduction of poverty for a nation's citizens and the sustainable growth of an economy.

Government intervention in an economy can take two forms — fiscal policy or monetary policy. Fiscal policy is controlled by government agencies and departments, while monetary policy is controlled by banks changing interest rates and selling government securities. The role of fiscal policy is to increase or decrease taxation and government spending depending on the needs of the economy. When an economy slows, a government can attempt to stimulate it through increased expenditure and lowered taxes, providing citizens with an increased amount of money to spend. Increased spending from more disposable income is returned to the government in taxes collected from sales at both local and national levels.

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In the short term, the role of fiscal policy is to stabilize a struggling economy by increasing the spending and making temporary tax cuts. Short-term tax cuts often have a minimal impact on an economy because the people given the tax cut often save the increased amount of money. The money saved is used for a perceived return to economic difficulties when the taxation changes return to previous levels. Economic growth is the long-term aim of fiscal policies introduced by a government at sustainable levels that do not allow an economy to grow at uncontrollably fast or slow levels.

Government fiscal policies often include stabilizers that automatically kick into action when the economy grows or reduces at alarming levels. An economic downturn sees more government expenditure on unemployment benefits and healthcare, with government spending adjusted at small levels without legislative interference. A slowing economy is often stimulated at small levels by reductions in taxation to promote spending.

Throughout history, the role of fiscal policy has changed due to the needs of a country at a specific moment. Prior to the Great Depression of the 1930s, most governments did not interfere with the running of their economy in a significant way, but allowed market forces to govern the growth of the economy. The worldwide economic crash of the 1930s prompted governments to intervene and establish fiscal policies to provide stabilization. By the end of the 20th century, government policies in most nations had returned fiscal control to the stock market and investment markets, followed by the economic downturn of the first decade of the 21st century prompting more government involvement in fiscal policy.

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Discuss this Article

literally45
Post 3

People are happy when fiscal policy implements tax cuts and increased government spending. It's good for the economy but terrible for our budget. That's why our government has to borrow a lot of money to manage their budget deficit. I heard a joke last year in 2013, that considering the amount of money we have borrowed from China, that China owns the U.S. now. It's funny and sad at the same time because it's true.

bear78
Post 2

@ZipLine-- That's a great question. Just like monetary policy, fiscal policy can be expansionary or restrictive. Fiscal policy doesn't always increase spending and lower taxes, it can do the opposite if economic growth is too much/unsustainable.

If inflation and consumer spending is too high, fiscal policy will increase taxes to cut spending. This is also a great way to decrease a budget deficit.

For the most part, monetary policy and fiscal policy are supportive of one another. Most governments prefer to use monetary policy first when the economy is not doing well. Fiscal policy changes will follow monetary policy if the former is not enough.

ZipLine
Post 1

As far as I know, monetary policy is changed not only when the economy is slow, but also when the economy is growing rapidly. Does fiscal policy also change when the economy is growing too quickly or does it only change when the economy is slow?

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