Meaning of Fiscal Policy

Acronyms Business

Fiscal policy is a sub-area of ​​financial policy and includes all monetary measures of a state that affect the economy. It is therefore an important economic policy control instrument. Through its fiscal policy, a state can exert significant influence on the cyclical or economic development.

  • Fiscal policy comprises all (financial) measures that government agencies can order in order to influence the development of the economy.
  • A countercyclical fiscal policy compensates for fluctuations, i.e. it supports the economy during a downturn and slows it down during a boom.
  • In the case of pro-cyclical fiscal policy, on the other hand, the measures point in the same direction as the economic trend. Government spending increases when it is high, and decreases when it is low.
  • In order to stimulate economic development, states fall back on expansionary instruments, whereas they use restrictive instruments to weaken the economy.

Countercyclical fiscal policy

The idea of ​​countercyclical fiscal policy first appeared in the 1930s and goes back to the British economist John Maynard Keynes. The basis of his concept is based on the premise that markets have a tendency towards occasional instability and are only in equilibrium in the long run. This manifests itself in economic fluctuations, which cause an ups and downs in the economy and, to a certain extent, even crisis situations. It is therefore the task of the state to contribute to economic stability through an anti-cyclical fiscal policy.

The aim of countercyclical fiscal policy is therefore to cushion both phases of recession and times of boom. In order to stimulate the economy during a recession, the state must therefore reduce reserves or run a deficit. As a rule, such a policy leads to an increase in national debt. In phases of strong economic growth, on the other hand, it is the state’s task to build up reserves or reduce debts. According to abbreviationfinder, FPI stands for Fiscal Policy Institute.

However, the implementation of this concept is often difficult because politicians often only react or can only react with a delay. However, since the financial crisis in 2007, the importance of countercyclical fiscal policy has increased significantly worldwide. Most states tried to stabilize the economy through extensive aid packages.

Procyclical fiscal policy

Procyclical fiscal policy is the counterpart to countercyclical fiscal policy. As a result, the effect of the measures taken by the state is pointing in the same direction as the business cycle. As tax revenue falls during a period of economic downturn, the state reduces its expenditure. During a boom, the state uses the higher tax revenues to increase its spending. The fluctuations are therefore not balanced out. Instead, the rashes intensify. In principle, most economists are more in favor of countercyclical fiscal policy.

In some cases, the pro-cyclical fiscal policy also occurs unintentionally. Under certain circumstances, countercyclical measures may only take effect after a delay or only when the business cycle is already in the next phase. For example, it can happen that a funding package decided during a recession only takes effect during an upswing and thus reinforces it.

Expansive fiscal policy

The aim of an expansive fiscal policy is to stimulate overall economic demand and to support the economy or to avert or slow down a recession. It usually does this by increasing public spending and creating deficits. The most important actors in this context are the elected representatives of the people, the finance ministries and the treasuries of the municipalities and municipal associations. The expansive fiscal policy is used in the sense of the countercyclical model especially in a phase of downturn.

Expansive fiscal measures

To the economic growth to increase, are States different options. Above all, this includes:

  • Tax cuts
  • Expansion of social benefits
  • Employment programs
  • Increased public procurement
  • Increase in subsidies

Restrictive fiscal policy

A restrictive (also contractionary) fiscal policy aims to dampen the economy in order to prevent the economy from overheating. The state can achieve this either by reducing its expenditure or by increasing taxes. Ideally, there will be surpluses, which will then be used in phases of downturn.

Restrictive fiscal measures

States can also take various measures to limit economic growth and the associated inflation. The following list shows which of these are essentially:

  • Tax increases (e.g. income and consumption taxes)
  • Reduction of social benefits
  • Dismantling of employment programs
  • Restriction of public contracts
  • Elimination of subsidies