Fiscal Policy

Governments use fiscal policy alongside monetary policy, which is usually run by the central bank. While monetary policy works mainly through interest rates and the money supply, fiscal policy works through the government's own budget.

Expansionary fiscal policy involves increasing government spending, cutting taxes or both. It is typically used during recessions to boost demand. For example, a government might fund infrastructure projects or send payments to households to encourage spending.

Contractionary fiscal policy involves cutting spending or raising taxes. It may be used to cool an overheating economy or to reduce budget deficits and government debt.

Some fiscal effects happen automatically. During a recession, tax revenues fall and spending on unemployment benefits rises without new decisions, helping to support demand. These are called automatic stabilisers.

Fiscal policy can be slow to implement, because changes to taxes and spending usually require political agreement. Large deficits used to fund expansionary policy add to government debt, which must be financed and may limit future choices.