Reviewed by Oct 05, 2020| Updated on
Fiscal policy is a policy via which a government makes adjustments in its tax rates and spending levels to influence and monitor a nation's economy. It is a sister strategy in relation with the monetary policy by which a central bank impacts the money supply of a nation. Both these policies are utilised in several combinations to direct the economic goals of a country.
Fiscal policy is considered as contractionary or tight when the revenue is higher as compared to spending i.e., the budget of the government is in surplus. Fiscal policy is considered as loose or expansionary when spending is higher as compared to revenue i.e., the budget of the government is in deficit. Mostly, the focus lies on the change in deficit and not on the level of the deficit.
Also, a fiscal policy has an impact on the trade balance and the exchange rate in an open economy. In the event of fiscal expansion, a rise in interest rates will attract foreign capital because of government borrowing.
Fiscal policy helps accelerate economic growth by raising the rate of investment in public as well as private sectors. In the short run, it can impact the level of activity in the economy by changing aggregate demand for goods and services.
Governments utilise fiscal policy in order to make an impact on the level of aggregate demand within the economy, so that specific economic goals such as price stability, economic growth, and full employment are achieved.