Fiscal policy refers to the economic strategy that the government uses to manipulate its economy by controlling the public expenditure and rates of taxation (Hansen, 2018).The government can either increase or decrease the number of funds to spend. Similarly, taxes are always used to control the economic environment by either encouraging or discouraging some trading activities to ensure a productive economic environment.
British economist John Maynard Keynes developed the theory of fiscal policy to illustrate the roles played by taxation and government spending (Davidson, 2017). His theory is commonly referred to as Keynesian economics. Fiscal policy has a greater impact to curb the rate and levels of inflation.
For instance, increasing government expenditure through activities such as government projects, or sometimes by lowering taxes increases the amount of money injected into a circular flow of income. This is dangerous supposedly it will increase the purchasing power of citizens prompting increased demand and consequently demand-pull inflation.
On the other hand, when the government raises taxes beyond the acceptable limits, the cost of production increases affecting the economy from the implications of cost-push inflation. In other words, government expenditure and taxation is a tool to control the circular flow income. Government expenditure and taxation are the two major tools of fiscal policy. Transfer of payments is also one of the fiscal policy that the government uses to stabilize the economy. Transfer of payments can be cited in activities such as trading sin social securities, unemployment checks, and welfare services. The three tools of fiscal policies can be used in either of the two ways that is to expand the economy or to reduce and restrict the expansion of the economy. The Federal Reserve or central bank usually increases the supply of money by purchasing securities and reducing the injection of money when they sell securities.
Davidson, P. (2017). John Maynard Keynes. Springer.
Hansen, A. H. (2018). Monetary theory and fiscal policy. Pickle Partners Publishing.