Fiscal policy

Fiscal policy, or   fiscal policy , is a type of economic policy in which the government manipulates its income or expenses in an attempt to achieve economic stability.

The government uses the charges and expenses it has as control instruments, with the objective that the economy is creating jobs, has reduced inflation and the distribution of income.

Another economic policy that can work together to improve the economy is known as monetary policy.

Expansionary fiscal policy and contractionary fiscal policy

Fiscal policy takes into account the so-called “potential product” of when the economy produces the exact amount needed and that the government takes as a target for the country’s GDP.

What can happen is that the country’s production is below or above expectations and when that happens, the State intervenes so that the economy returns to its potential.

When GDP exceeds expectations, there will be more demand than the supply of products and services, with an increase in inflation, reducing the purchasing power of the population.

Otherwise, with a much lower GDP than expected, there will be less demand than supply for products and services, leading to higher unemployment and lower wages.

In the case that the real GDP is above the expected GDP, it is known as the “inflationary gap” and, conversely, when the real GDP is below the expected product, the “deflationary gap”.

In this way, fiscal policy maintains the pace of GDP to achieve the most appropriate product. In a simple way we can say that:

  • Expansive fiscal policy (expansive):  made with the objective of increasing the performance of the country’s economy, when it is well below expectations (recession);
  • Contractive fiscal policy (restrictive):  carried out with the objective of contracting the income of the country’s economy, when it is much higher than expected.

In expansionary fiscal policy, planning is carried out through public investment spending, so that the economy can grow again. The idea is that, in times of economic crisis, there will be more agents to save and, with this, the contraction of the product. The government takes steps to make people consume more.

Contractionary fiscal policy occurs when the economy grows beyond expectations, where prices begin to rise with high demand. Planning will be the other way around, that is, higher taxes and lower public spending.