Reviewed by Omotolani Ajileye
Edited by Paul Elegbeleye
Table of Contents
Meaning of Fiscal Policy
Fiscal policy refers to the deliberate actions taken by the government to influence economic activities through the use of taxation, government expenditure and public borrowing.
Government uses fiscal policy to achieve important economic objectives such as promoting economic growth, reducing unemployment, controlling inflation, maintaining price stability and improving the distribution of income.
For example, when unemployment is high, the government may increase its spending on roads, schools and other public projects to create jobs and stimulate economic activity. On the other hand, when inflation is high, the government may increase taxes or reduce its expenditure to reduce excessive demand in the economy.
Objectives of Fiscal Policy
The major objectives include:
1. Full Employment
One of the major objectives of fiscal policy is to achieve full employment, which means creating conditions where people who are willing and able to work can find jobs.
When unemployment is high, the government can adopt an expansionary fiscal policy by increasing its expenditure on projects such as road construction, schools, hospitals and other infrastructure. These projects create direct employment for workers and also generate indirect employment through increased demand for goods and services.
Government can also reduce taxes to increase people’s disposable income and encourage consumption and production, which can lead to more employment opportunities.
2. Price Stability
Fiscal policy is used to maintain stable prices and control inflation or deflation. When prices are rising rapidly, the government can reduce its expenditure or increase taxes to reduce the amount of money available for spending.
Lower demand can help reduce pressure on prices. On the other hand, when there is deflation or a serious fall in economic activity, government can increase expenditure or reduce taxes to encourage spending and production. Therefore, appropriate fiscal measures can help prevent extreme changes in the general price level.
3. Economic Growth
Another objective of fiscal policy is to promote economic growth, which refers to an increase in the production of goods and services in an economy over time.
Government can promote growth by spending money on infrastructure such as roads, electricity, railways, schools and hospitals. Investment in education and healthcare also improves the quality and productivity of the labour force.
In addition, government may provide tax incentives to encourage businesses to invest and expand their operations. These activities can increase production, employment and national income.
4. Equitable Distribution of Income
Fiscal policy is also used to achieve a fairer distribution of income among different groups in society. There may be a wide difference between the incomes of high-income and low-income earners.
Government can reduce this inequality by imposing relatively higher taxes on people with higher incomes and using the revenue to provide services and programmes that benefit lower-income groups. Such expenditure may include free or subsidised education, healthcare, social welfare programmes and other public services.
In this way, fiscal policy can help improve the economic well-being of disadvantaged groups.
5. Balance of Payments Equilibrium
Fiscal policy can be used to help maintain a favourable balance of payments position. A country may experience a balance of payments problem when it consistently spends more foreign currency on imports than it earns from exports and other foreign receipts.
Government can use taxation and expenditure measures to influence domestic demand and the level of imports. For example, higher taxes or reduced government expenditure can reduce excessive demand for imported goods.
Government can also provide incentives for domestic production and exports, helping the country earn more foreign exchange and reduce dependence on imports.
6. Economic Stability
Fiscal policy aims to promote overall economic stability by reducing large fluctuations in economic activity. An economy may experience periods of rapid growth followed by recession, unemployment and declining production.
During a recession, government can increase expenditure or reduce taxes to stimulate economic activity. During periods of excessive economic expansion and high inflation, it can reduce expenditure or increase taxes.
By adjusting its revenue and expenditure, government attempts to smooth out these fluctuations and create a more stable economic environment.
7. Development of Infrastructure
Fiscal policy is used to support the development and maintenance of infrastructure needed for economic activities.
Government can allocate public funds to construct and maintain roads, bridges, schools, hospitals, electricity systems, water facilities, airports and other infrastructure. Good infrastructure reduces the cost of doing business and makes it easier for people and goods to move from one location to another.
It can also attract private investment and improve productivity. Therefore, government expenditure through fiscal policy can contribute significantly to the long-term development of an economy.
Types of Fiscal Policy
There are two major types:
A. Expansionary Fiscal Policy
Expansionary fiscal policy is a fiscal policy used by the government to increase economic activities when the economy is experiencing low production, unemployment or recession.
Under this policy, the government may increase its expenditure, reduce taxes, or do both. When government spends more, it puts more money into the economy, which can increase people’s incomes, consumption and demand for goods and services.
For example, government may construct roads, schools and hospitals, creating employment for workers and increasing economic activity. Expansionary fiscal policy is therefore mainly used to reduce unemployment, stimulate economic growth and increase aggregate demand. However, excessive use of this policy may lead to inflation.
B. Contractionary Fiscal Policy
Contractionary fiscal policy is a fiscal policy used by the government to reduce economic activities when there is excessive demand and high inflation in the economy.
Under this policy, the government may reduce its expenditure, increase taxes, or do both. Reducing government spending lowers the amount of money entering the economy, while higher taxes reduce the disposable income available to households and businesses. This can reduce consumption and investment, thereby lowering aggregate demand and helping to control inflation.
For example, government may reduce spending on non-essential projects or increase certain taxes when prices are rising rapidly. However, excessive use of contractionary fiscal policy may reduce production, investment and employment.
Summary
Fiscal policy is the deliberate use of government taxation, expenditure and borrowing to influence economic activities.
Government uses fiscal policy to:
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Promote economic growth.
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Reduce unemployment.
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Control inflation.
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Maintain price stability.
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Redistribute income.
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Promote economic stability.
Two major types are:
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Expansionary fiscal policy: increases government spending or reduces taxes to stimulate the economy.
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Contractionary fiscal policy: reduces government spending or increases taxes to control inflation.
Also Read:
Understanding the Main Concepts of Demand and Supply 3
