Fiscal Policy

Fiscal policy is used by governments to influence the level of aggregate demand in the economy, in an effort to achieve price stability, full employment and economic growth.

The government influences the direction of the economy through changes in the two instruments: government taxes and government spending. Changes in the level and composition of taxation and government spending can impact the following variables in the economy, for example:

• Aggregate demand and the level of economic activity
• The pattern of resource allocation
• The distribution of income.

Depending on if government spending is fully funded by tax revenue, the fiscal policy can be neutral, expansionary or contractionary.