What is fiscal policy?
Fiscal policy refers to ways of using government revenue collection, namely taxes, and spending it with the aim of influencing the economy. By altering the levels of taxation and public expenditure, a government’s goal is to modify the aggregate demand and economic activity, trying to stabilise the economy over the business cycle.
How fiscal policy works
Fiscal policies are inspired by the Keynesian economic theory, developed by John Maynard Keynes as a critic of the laissez-faire approach, predominant during the first third of the 20th century. After the 1929 stockmarket crash and the subsequent Great Depression throughout the 30s and early 40s, most national governments started applying some kind of fiscal and monetary policy.
Instead of trusting in the free market to regulate the economy, Keynes proposed that government should take a proactive role to regulate business cycles – hence keeping unemployment, inflation and the cost of money under “desirable” levels.
This interventionist approach has its negative side, as each government depends on political orientations and philosophies.
Differences between fiscal policy and monetary policy
The main difference between fiscal and monetary policy is that the first is executed by government or parliament departments, whereas the latter is usually administered by a central bank.
Fiscal policy only deals with taxes and government spending, while monetary policy focuses on controlling the money supply, setting up interest rates and lending rates. In most cases, the central bank is dependant of a national government, and its actions regarding monetary policy will be coordinated with the fiscal policy tactics.
Category: Financial Glossary