Fiscal policy is the use of taxation and government expenditure to achieve the government's economic objectives. The use of fiscal policy to influence the level of
aggregate demand and, hence, national income is one way the government can control the economy. In seeking to control the economy, the government will try to promote economic growth, stable prices and low levels of unemployment and will try to avoid large deficits on the current account of the
Balance of
Payments.It will usually be difficult to achieve these all at once, but
governments will act according to their priorities at any one time.
Expansionary fiscal policies will promote economic growth and high levels of employment. They may lead to accelerating inflation. They may lead to increases in imports as well. Further, the buoyant home market may deter firms from exporting, which demands more effort than selling in the domestic market. So, fiscal expansion may produce a current account deficit. Contractionary policies reduce inflation, but also growth and employment. However, imports will fall and firms are likely to look to export markets to maintain sales. So, the current market will improve.
Fiscal policy can also be used to redistribute income and wealth, which may be a further objective of government policy. Progressive income taxes raise funds which can provide benefits for those who are badly off. Capital gains tax and inheritance tax reduce somewhat the value of individuals' holdings of wealth.
Different governments have different approaches to fiscal policy. During the 1980s fiscal policy became steadily less and less important as a macroeconomic policy tool. Also, rather less redistribution of income took place. This had an effect on the overall distribution of income and wealth. In the 1990s the need to reduce government borrowing led to substantial tax increases, despite the government's overall commitment to tax cuts.