The two major elements of fiscal policy are government spending and taxation. These tools are used to influence the economy’s overall activity and promote growth, stability, and employment.
1. Government Spending: This involves the total expenditures a government makes in various sectors such as infrastructure, education, healthcare, and defense. When the government increases spending, it injects money into the economy, which can create jobs, encourage production, and stimulate demand for goods and services. For instance, during a recession, increased government spending can help boost economic activity by directly providing jobs and income.
2. Taxation: Fiscal policy also includes changes in tax rates and tax structures. Lowering taxes can increase consumers’ disposable income, encouraging them to spend more and boost demand. Conversely, increasing taxes can help cool down an overheating economy. The government can adjust tax policies to help reduce inflation or control spending by the public.
Fiscal policy is crucial in managing the business cycle, which consists of periods of expansion and contraction in economic activity. During a contraction, such as a recession, governments typically respond with expansionary fiscal policy by increasing spending or cutting taxes to stimulate demand. This encourages consumer spending and investment, which can help accelerate economic recovery. On the other hand, during periods of expansion when the economy is overheating, governments might adopt contractionary fiscal policy by reducing spending or increasing taxes to help slow down inflation and maintain economic stability.