Fiscal policy is a tool used by the government to control the economy, and it is independent of the central bank. It depends on taxes and government expenditures. Fiscal policies can be further divided into contractionary or expansionary policies. Under the contractionary fiscal policy, the government reduces its spending while escalating taxation.  The effect of this is that capital available to private businesses will reduce, which will contract the economy (Forsythe). This method is used to control inflation for an economy that is growing rapidly. High taxes will discourage the production and economic output as it reduces total demand and supply. Contractionary policies will, therefore, reduce private investment, which means unemployment rates will move up. Usually, contractionary policies are followed by monetary policies that reduce the GDP, such as increased interest rates which lower the money supply. Contractionary policies are rarely used because government leaders know the citizens who voted them in do not like paying high taxes.

When the government wants to boost economic growth, it deploys expansionary policies, which entail lowering taxes and incrementing government spending (Forsythe). With taxes being low private sectors are enticed to invest more, creating more job opportunities for the local citizens. The main goal of this measure is to increase economic activities; hence the government can even make payments to consumers through tax refunds. These acts increase the aggregate demand and supply, leading to more production and, therefore, high economic output. Monetary policies accompanying expansionary fiscal policies are interest rates reduction and increment of money supply in the money market. The initiation of expansionary policies increases the GDP; therefore, it can be used to resolve deflation.

Works Cited

Forsythe, Aaron. “Fiscal Policy – Macroeconomics.” Fundamental Economics, 2012, Accessed 10 June 2019.