How Fiscal Policy Influences Economic Growth
Fiscal policy is one of the most influential tools that a government employs to influence the economy. The fiscal policy of a country determines how the government spends its money and taxes its citizens. Fiscal policy impacts elements of the economy ranging from inflation to employment to the growth of the business sector. Fiscal policy is established alongside monetary policy to influence financial markets.
Additionally, fiscal policy is of much concern to investors because it can have a considerable influence upon the growth of the economy. While the effects of fiscal policy may take some time to manifest themselves, fiscal policy can significantly impact the economy in both the short and long term.
Understanding how fiscal policy influences the economy provides investors with essential context regarding market movements and economic perspectives.
What Is Fiscal Policy?
Fiscal policy involves the spending of the government and the taxation of citizens to influence economic activity.
A government establishes fiscal policy through decisions regarding public infrastructure spending, tax rates, social programs, government investment, budget deficits and surpluses.
Fiscal policy is established through the legislative process and published within the government’s annual budget.
Expansionary Fiscal Policy
An expansionary fiscal policy is established to increase economic activity within the economy when the economy is slowing.
A government may implement an expansionary fiscal policy by increasing public spending, decreasing taxes, increasing infrastructure spending for the government and increasing benefits for citizens.
An expansionary fiscal policy is typically established during economic downturns or years of poor economic activity and growth.
Contractionary Fiscal Policy
A contractionary fiscal policy is established to reduce the economic activity within the economy if inflation is rising or if the economy is growing at an unsustainable rate.
A government may implement a contractionary fiscal policy by reducing public spending, increasing taxes, limiting budget deficits and reducing government investment.
A contractionary fiscal policy can be used to attain the government’s macroeconomic objectives.
Fiscal Policy and Employment
The spending of the government has a direct influence upon the number of people employed within the economy.
Public infrastructure spending leads to the creation of employment opportunities and increases the number of people employed within the economy.
Additionally, increased employment increases the income of citizens, increasing the spending power of those individuals and the overall growth of the economy.
Reduced spending of the government on public projects can have the same impact upon the creation of jobs.
Business Investment and Fiscal Policy
Business investment is also influenced by fiscal policy.
Businesses monitor fiscal policy decisions regarding taxes upon businesses, business investment incentives, business capital expenditures and infrastructure spending within the economy.
If a business investment policy is favorable to the business, the business may increase its area of operations, its number of employees and its investments in new technologies.
Fiscal Policy and Financial Markets
The financial markets are influenced by the fiscal policy of a government.
Investors consider the impact of fiscal policy on the earnings of businesses, the spending of the government on public projects, the bond and stock markets, the spending power of citizens and the level of business confidence within the country.
The implementation of a fiscal policy regarding large infrastructure projects or tax changes can influence the markets’ expectation of the growth of the economy.
Government Debt
A government’s fiscal policy can also influence the amount of debt that the government must use to finance its programs.
If a government establishes a budget deficit year after year, the level of public debt increases.
The public and investors closely monitor a government’s fiscal policy to determine its level of government debt, fiscal policy, budget balances and economic growth of the government.
While government debt can be used to fund projects that lead to economic growth, governments must manage this debt to ensure that the economy remains financially stable.
Fiscal Policy and Inflation
The spending of the government also has an influence upon inflation within the country.
If government spending increases beyond the country’s capacity to supply the goods and services that are to be purchased by the government, inflation will increase.
The opposite can be said of a government that establishes a fiscal policy that restrains government spending.
Inflation impacts the spending power of citizens and the cost of running businesses.
Understanding the links between inflation, spending and fiscal policy can help investors to understand the government’s fiscal objectives.
Key Takeaways
Fiscal policy uses the government’s spending power and taxation power to influence economic activity.
An expansionary fiscal policy is used to stimulate the economy during periods of slowdown.
A contractionary fiscal policy can be used to moderate inflation.
Fiscal policy influences the number of people employed and the spending power of citizens.
Business investment decisions are influenced by fiscal policy decisions.
Financial markets are influenced by fiscal policy.
The government debt of a nation is influenced by its fiscal policy.
Fiscal policy has an influence upon inflation within a national economy.
Conclusion
Fiscal policy is one of the most influential forces that influence the economy of a nation. Through fiscal policy, which determines how the government spends and taxes the nation’s citizens, the government has the ability to influence the number of people employed in the country, the growth of business activity, business and consumer spending power, financial markets and economic growth. While the impact of fiscal policy may take some time to manifest itself, understanding the role that fiscal policy plays within the economy provides investors with valuable insights into the economy and the factors that influence the long-term performance of the market.