Fiscal policy is a term you might have heard in the news or when discussing the economy, but what does it really mean? 

Have you ever wondered how governments decide how much to spend or how much to tax? 

Or why sometimes there are big changes in taxes, or the government suddenly spends a lot more or less? 

These decisions are not random, they’re part of fiscal policy. It plays a huge role in shaping the economy, and understanding it can help you see how it affects your life, even if you don’t realize it. 

Let’s look into what fiscal policy is, types of fiscal policy, and how it impacts us all.

What Is Fiscal Policy?

Fiscal policy refers to the actions a government takes to manage its spending and taxation to influence the economy. 

In simple words, it’s the way governments use their financial tools to manage a country’s economic health. 

This includes things like how much they spend on things like roads, schools, and healthcare, and how much they collect through taxes like income tax or sales tax.

Governments use it to either boost the economy or cool it down, depending on the situation. But how exactly do they do that?

The Two Types of Fiscal Policy

The different types of fiscal policy are as follows:

1. Expansionary Fiscal Policy

When the economy is struggling, and there’s not enough money flowing around, the government might decide to spend more money or reduce taxes. 

This is known as expansionary fiscal policy. The goal is to give the economy a boost. In the economy, this is like pushing more money into the system to get things going again.

For example, when the government builds new schools, highways, or hospitals, it’s spending money to help create jobs and stimulate growth. 

Similarly, lowering taxes means people have more money to spend, which can also help the economy grow.

2. Contractionary Fiscal Policy

On the other hand, when the economy is growing too fast and inflation (the rise in prices) becomes a problem, the government might want to slow things down. 

This is when contractionary fiscal policy comes into play. In this case, the government might reduce its spending or increase taxes to take money out of the economy, which helps prevent things from overheating.

Think of it like when you’re playing a game and someone gets too carried away, you might need to slow them down a bit so things don’t get out of control.

Why Is It Important?

You might be wondering, “Why does it matter to me?” Well, this affects everyone in the country. Below is how:

• Jobs: When the government spends money on things like building new roads or schools, it creates jobs. This means people can earn money, spend it on goods and services, and contribute to the economy.

• Inflation: If the government spends too much money without enough income (through taxes), it can cause inflation. This means prices go up, and the money you have today might not buy as much tomorrow.

• Interest Rates: It can also affect interest rates. For instance, if the government needs to borrow money to spend, it might raise interest rates to attract people to lend them money.

Fiscal Policy and Forex (Foreign Exchange)

Now, if you’re looking at things from a Forex (foreign exchange) point of view, fiscal policy can play an important role in the value of a country’s currency. This is how,

When a government is using expansionary fiscal policy (spending more or cutting taxes), it might borrow more money, which could lead to a rise in the national debt. 

If other countries see that the debt is rising, they may lose confidence in the country’s currency, causing it to weaken. 

This could affect how much that currency is worth when exchanged for other currencies.

On the other hand, if the government is cutting spending and reducing debt, it might boost confidence in the country’s economy, leading to a stronger currency.

Conclusion

Fiscal policy is one of the most important tools governments use to guide a country’s economy. 

Whether it’s spending more money to create jobs during tough times or slowing down the economy when things are growing too fast, it impacts the lives of everyone. 

For those who follow Forex, it’s also a critical factor in determining the value of a currency. 

By understanding how this works, you get a better idea of the decisions that affect your pocketbook, your job, and the economy at large.

Related terms

Monetary Easing

Fiscal Dominance