In economics and political science, fiscal policy refers to the use of government revenue collection (taxes or tax cuts) and expenditure to influence a country’s economy. This approach developed as a response to the Great Depression of the 1930s, when the previous laissez-faire economic management approach became unworkable. The foundation of fiscal policy lies in the theories of the British economist John Maynard Keynes, whose Keynesian economics suggested that government changes in taxation and spending influence aggregate demand and economic activity levels.
Role of Fiscal Policy
Fiscal policy, along with monetary policy, is a key strategy used by a country’s government and central bank to advance economic objectives. It allows authorities to target inflation, increase employment, and stabilize the economy over the business cycle. In modern economies, maintaining inflation in the range of 2%–3%, with GDP growth and unemployment rate targets, is a common objective of fiscal policy.
Impact of Fiscal Policy
Changes in the level and composition of taxation and government spending can significantly affect macroeconomic variables, including aggregate demand, saving and investment, income distribution, and the allocation of resources. This distinguishes fiscal policy from monetary policy, which deals with the money supply, interest rates, and is often administered by a country’s central bank.
Fiscal policy and monetary policy both play crucial roles in influencing a country’s economic performance.