Fiscal policy is important because it regulates government spending and taxation. Fiscal policy controls decisions made at the local, national and federal government levels, such as goods, services and products purchased, appropriate levels of taxation and government financial programs. Fiscal policies affect specific population segments, such as the middle class and people living in certain states, and influence the national economy.
Fiscal policies wax and wane with economic conditions. Fiscal policy restricts when government revenue exceeds spending. However, it loosens when government spending outpaces revenue. Fiscal policy produces short-term and long-term economic effects. Fiscal policy initially impacts the national economy by controlling demand for goods and services. The government increases aggregate demand by stabilizing tax rates and increasing expenditures. It also boosts demand through tax cuts and increased transfer payments. These measures increase average household income levels, encouraging consumer spending. Fiscal policy also influences exchange rate and trade balance in the international economic arena. Fiscal expansion prompts higher interest rates, as the government borrows money to attract foreign capital and investments. In addition to regulating the demand side of the economy, fiscal policy influences economic output. After the government raises demand for goods and services, production increases, as does prices of goods and services. Fiscal policy gives the government power to correct economic imbalances during recessions and depressions as well.