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What Is the Relationship between Fiscal Policy and Economic Growth?

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  • Written By: Esther Ejim
  • Edited By: Kaci Lane Hindman
  • Last Modified Date: 21 November 2016
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Inferences about the relationship between fiscal policy and economic growth can be drawn from the manner in which fiscal policy affects the economy at large. Fiscal policy is a governmental tool for economic manipulation to an identified or stated purpose. For instance, the relationship between fiscal policy and economic growth can be seen in a situation where fiscal policy is used for economic expansionary purposes. The same is also apparent when fiscal policy is applied for in order to reduce demand.

The main vehicles for the application of fiscal policy are the twin macroeconomic factors of governmental spending and taxation. Governmental spending as a method of fiscal policy and economic growth occurs when the government increases or decreases its spending with applicable results. Money is spent by the government in a lot of areas that include, but are not limited to, education, defense and for payments like welfare benefits. The government might decide to stimulate a lackluster economy by increasing its spending and decreasing the taxes, consequently increasing consumer spending.

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When the government decreases the tax rates, it leaves the consumers with more disposable personal income to spend. At the same time, the injection of money into the economy by the government through increased spending also increases the amount of money in circulation in the economy, giving people more access to needed funds that may then be spent on various purchases. The purpose behind this is to foster an increase in the aggregate demand for services and other products in the economy. This shows a connection between fiscal policy and economic growth, because such an increase in consumer demand will serve as a much needed boost to an otherwise sluggish economy.

Another way in which the decision by the government to spend more can impact the economy is through the creation of jobs. For instance, if the government decides to spend money on infrastructure-related projects like the construction of roads, such a procedure will also lead to the creation of jobs. This decreases the unemployment level in the country and also affects the economy in a positive light, because when people have jobs they also have the money to spend on goods and services, leading to a revival of an economy that is in a lull. In the same sense, the same principle can be used by the government to put a rein on an overheated economy. When the economy is too active, the government will increase taxes and reduce spending in order to mop up the excess of cash in the economy.

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