Fiscal policy – definition

Fiscal policy refers to the use of taxes and government spending to achieve desirable changes in aggregate demand.

There are three components of fiscal policy:

    1. Discretionary changes in tax rates – this generally means making changes in tax rates at times when they are needed. These changes are typally  implemented in a country’s annual budget, though they can be implemented outside of the official budget if required. There are many administrative costs to firms associated with changing tax rates – hence changes tend to be made only once a year – on budget day.
    2. Discretionary public spending changes – which occur either at the time of the annual budget, or at some other fixed time – in the UK such changes are normally made in what is called the ‘Autumn statement’ in November.
    3. The third component of fiscal policy involves ‘automatic stabilisers’. This involves the stabilisation of the economic cycle through two processes called fiscal drag and fiscal boost. When combined they help automatically stabilise the macro-economy when faced with an economic shock.

More on fiscal policy