What does fiscal policy involve?

Fiscal policy involves the use of government spending and taxation to influence the economy. It is a fundamental tool used by governments to manage economic activities, such as stimulating growth during a recession or cooling down an overheated economy. Through fiscal policy, the government adjusts its spending levels and tax rates to monitor and direct economic performance, aiming to influence aggregate demand, employment levels, and inflation rates.

For example, during an economic downturn, a government might increase spending on infrastructure projects and reduce taxes to stimulate economic activity. Conversely, during times of high inflation, it might decrease spending and increase taxes to help stabilize prices. This proactive approach makes fiscal policy a critical component of macroeconomic management, helping to regulate the overall economic environment for both households and businesses.