Depending on the state of the economy, fiscal policy can be directed towards different objectives, such as mediating inflation to restrict economic growth or stimulating economic growth by reducing taxes and encouraging spending on various projects. The three stances of fiscal policy are as follows:
Neutral Fiscal Policy:
- Implemented when an economy is neither in a recession nor in an expansion phase.
- Involves government deficit spending remaining consistent over time, with no significant changes that would impact economic activity.
Expansionary Fiscal Policy:
- Used during recessionary periods to address economic contraction.
- Involves government spending exceeding tax revenue, often through increased spending on public works and providing tax cuts to boost purchasing power and demand.
Contractionary Fiscal Policy:
- Implemented to counter excessive inflation and unsustainable economic growth.
- Involves increasing tax rates and reducing government spending to restrain inflation and reduce aggregate income, particularly when growth becomes unsustainable.
Considerations for Definitions
It’s important to note that cyclic fluctuations of the economy can impact tax revenues and certain types of government spending, even without changes in spending or tax laws. These fluctuations are not considered policy changes. Therefore, “government spending” and “tax revenue” are typically replaced by “cyclically adjusted government spending” and “cyclically adjusted tax revenue” in the context of the defined stances of fiscal policy. This adjustment ensures that a government budget balanced over the business cycle is considered to represent a neutral and effective fiscal policy stance.