Explain the concept of Fiscal Policy?

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pohnpei397 eNotes educator| Certified Educator

In macroeconomics, fiscal policy refers to the efforts by the government to use taxes and government spending to ensure the smooth running of the macroeconomy.  That is, the government uses these tools to try to prevent high unemployment and high inflation.

If the economy faces a recession, the government is supposed to cut taxes and increase spending.  When it does this, people have more money and can buy more goods and services.  This will lead to more jobs for people who make those goods and services.

By contrast, if the government fears inflation, it is supposed to raise taxes and cut spending.  This decreases the amount of disposable income that people have and so they spend less and prices do not rise.

krishna-agrawala | Student

Fiscal policy refers to a government's decisions on taxing and spending programmes. Most economics believe that fiscal policy together with monetary policy as the most important means of regulating the rate of inflation in an economy and preventing or controlling depression.

A government can use fiscal policies to reduce the demand for goods and services. It can prevent depressions by encouraging spending, while rate of inflation can be controlled by discouraging spending. Tax rates, which are determined by fiscal policy, influence  level of spending by influencing the amount of money people have for spending.  A government can also decrease or increase its own spending to manage inflation and depression.