Glossary
Fiscal policy
Government decisions on taxes and spending used to influence the economy, as distinct from the central bank's monetary policy.
On this page
Fiscal policy is the use of government spending and taxation to shape economic activity. In the US it is set by Congress and the President through budgets, appropriations and tax law, while monetary policy is set by the independent Federal Reserve. Investors watch fiscal policy because it changes corporate profits through taxes, consumer demand through transfers, and interest rates through the amount of debt the Treasury must sell.
How it works
Expansionary policy raises spending or cuts taxes to boost demand, typically in a slowdown, and usually widens the budget deficit. Contractionary policy cuts spending or raises taxes to cool demand or shrink the deficit. Some effects are automatic: during a recession, tax receipts fall and unemployment benefits rise without any new law. These "automatic stabilizers" cushion downturns on their own.
A deficit is funded by issuing Treasury bills, notes and bonds. Larger issuance can push yields up unless demand from investors, or the Fed's own purchases, absorbs it.
Fiscal versus monetary
| Fiscal policy | Monetary policy | |
|---|---|---|
| Who decides (US) | Congress and the President | The FOMC |
| Main tools | Spending, taxes, transfers | Policy rate, balance sheet |
| Speed | Slow to legislate, can be targeted | Fast to change, broad effect |
The two can reinforce each other or pull in opposite directions; a large deficit during high inflation can force the central bank to keep rates higher than it otherwise would.