A fiscal policy is the measures that a government takes so as to stabilize its economy. It involves changing the allocations and levels of government expenditures and taxes. During sluggish economic times, the government cuts taxes and this leaves taxpayers with additional cash for spending, which increases consumption levels. In contrast, increasing taxes and reducing government spending causes contraction of the economy.
1. Controls inflation
Fiscal policy helps in fighting the rates of inflation in a country. Inflation means the increase in price of services of goods without an improvement in money. As such, consumers require paying more money for the regular services and products with less accessible cash. The government might attempt to combat inflation through making use of fiscal policy for controlling the speed at which the prices increase. A popular way of combating inflation is by releasing more resources into the economy. The government achieves this by buying government securities such as bonds, thus increasing cash flow.
2. Predicts mistakes
Government officials and economists predict what will occur in a certain economy over time and thus set the fiscal policy or regulation to meet those assumptions. However, false assumption can mean that the policy will basically hurt the economy, rather than assist it to maintain a steady growth. A good example of this is the stimulus issued by the American government in 2008. Most Americans utilized this money for paying existing debts rather than circulating it through buying services and products. The outcome was an ineffective economic stimulus.
3. Stimulates the economy
A government might use its fiscal policy for boosting the demand for aggregate in the economy. Aggregate demand refers to the overall demand for services and goods across a certain country. This demand can be increased in various ways such as cutting the indirect taxes so as to promote lower prices or cutting personal tax so as to create disposable income.
Fiscal policy therefore offers the most effective tool for not only stimulating economic growth, but also curbing inflation.