Fiscal Policy Definition. Fiscal Policy refers to measures taken by governments to stabilize the economy, specifically by adjusting tax policy, government spending, and other government initiatives directed at optimizing economic performance. When the economy is in recovery or experiencing slow growth, the government may cut taxes, leaving taxpayers with extra cash to spend and thereby increasing levels of consumption. An increase in spending on public-works projects may also provide stimulus by pumping more cash into the economy, thereby creating jobs and expanding the economy. Conversely, a decrease in government spending or an increase in taxes tends to cause the opposite effect, contraction. Fiscal policy is often used in tandem with monetary policy. During the Great Depression, John Maynard Keynes recommended that government stimulus spending was required to offset the cycle of expansion and contraction in the economy. Prior to this time, balanced budgets were always the objective. Fiscal policy is effective at stimulating a sluggish economy, but is not that useful in controlling an inflationary one. Monetary Policy is carried out by a country’s central bank, as opposed to the government directly.
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