What is Fiscal Policy? Types of Fiscal Policy

What is Fiscal Policy? Types of Fiscal Policy

Financial decisions taken by the government that influence the economy by money spending and buying ability of its citizens is known as fiscal policy.

Fiscal Policy

It means the use of spending and tax policies of the government to influence the economic conditions of the country, especially the macroeconomic conditions, which include the collective demand for goods and services, employment to the population, rate of inflation, and growth of the economy.

The money spending power of the citizens of a country improves their taxpaying ability; as a result, it influences and improves the country’s economy. The people of the country and its citizens pay direct and indirect taxes. More taxes improve the government’s funds that the government can utilise for the development of the country. Government builds roads, provides better education and health facilities, builds infrastructure, and starts more industries, in turn increasing employment.

Example of Fiscal Policy

For example: Sometimes the government decreases the taxes and increases the spending for a sudden boost in the economy if required. For that, spending on infrastructure projects increases to create better job opportunities, income, and other social programs.

Types of Fiscal Policy

Legislature can only have two types of major control over the economic and financial body of the country – one by discretionary fiscal policies and another by automatic stabilisers.

Automatic stabilisers are usually used to adjust the taxes and spending on goods and products. They usually create fiscal actions in an automated manner if some specific conditions match.

On the other hand, discretionary fiscal policies are one of those measures that are very commonly discussed and used by the government body. The government uses both monetary and fiscal policy to meet the economic objective of the country. Basically, the government has two types of discretionary policy options, one is expansionary, and another is contractionary.

These fiscal policies are used according to the requirements of the economic phase, sometimes for the boom and sometimes to slow down the recession. There are three types of fiscal policy majorly, which are discussed below:

Expansionary Fiscal Policy

It involves all the actions taken by the government to invest more money back into the economy. Putting more money back into the economy creates more demand for services and products. It also expands the job opportunities and increases the profit for the people and government. In other words, it stimulates economic growth.

For example, the Indian government uses an expansionary fiscal policy to slow the reduction time of the business. It is also known as the recession. In this case, the government either spends more, cuts down the taxes, or does both of them. The main motive is to give more money to the hands of the consumers to allow them to spend more. It can result in a budget deficit. Therefore, the government should use this with caution

Contractionary Fiscal Policy

Contractionary fiscal policy is the second type of fiscal policy, and it is normally used at the time of a boom in the economy. Sometimes expansion in the economy can also be dangerous, so in this case, the government tries to slow down the expansion so that it could not become so intense. This type of fiscal policy helps make the growth of the economy manageable and controls inflation.

Sometimes, the government started collecting high taxes from the people and reducing the spending to move down the investment price and increase the rate of unemployment. This is done because the economy demands the unemployed workers for the businesses. So, in this case, the tax revenue generated is more than the government’s spending.

Neutral Fiscal Policy

Neutral fiscal policy is generally used when the economy of the country is in equilibrium.

So, in a neutral fiscal policy, the spending of the government is funded by the department of tax revenue, and it will have a neutral effect on the levels of economic activity.

Objectives of Fiscal Policy

The main objectives of the fiscal policy are:

  • Fiscal policy maintains the growth rate of the economy.
  • It also helps in maintaining the price levels.
  • It encourages the economic development of the country.
  • It maintains the state of equilibrium in the balance of payments.


So, it can be concluded that when the government spending and tax policies impact the country’s economic conditions like employment, inflation, demand for goods and services, and growth of the economy.

There are different types of fiscal policy used by different countries as per the needs of the economy. There are three types of fiscal policy which are – neutral, contractionary, and expansionary.

Contractionary fiscal policy is the second type of fiscal policy, and it is normally used at the time of a boom in the economy. A neutral fiscal policy is used when the economy of the country is in equilibrium. In an expansionary fiscal policy, the government puts more money into the economy, creating more demand and services.