Cyclicality of the Fiscal Policy
- Definition: Cyclicality of fiscal policy refers to the relationship between the government’s fiscal actions (taxation and public spending) and the overall economic cycle. The economic cycle includes periods of economic expansion (growth) and contraction (recession).
Types
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Pro-Cyclical Fiscal Policy:
- Definition: A pro-cyclical fiscal policy is one where government spending and taxation decisions exacerbate the current phase of the economic cycle.
- Example:
- During periods of economic growth, the government may increase spending or cut taxes, further stimulating demand, leading to higher inflation or over-heating of the economy.
- During recessions, the government might reduce spending or increase taxes, worsening the downturn.
- Impact:
- During economic booms: Pro-cyclical policies can lead to inflationary pressures.
- During recessions: Can deepen the slowdown, as the reduction in spending or increased taxes can lower aggregate demand.
- Risk: It can destabilize the economy by intensifying fluctuations.
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Counter-Cyclical Fiscal Policy:
- Definition: A counter-cyclical fiscal policy aims to offset or counterbalance the fluctuations in the economic cycle, smoothing out the peaks and troughs.
- Example:
- During a recession: The government increases spending or reduces taxes to stimulate economic activity and increase aggregate demand.
- During an economic boom: The government reduces spending or increases taxes to cool down the economy and control inflation.
- Impact:
- During economic downturns: Helps boost demand and reduces the severity of recessions.
- During periods of expansion: Helps prevent the economy from overheating and keeps inflation under control.
- Goal: To stabilize economic growth and maintain sustainable growth by moderating the business cycle.
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Neutral Fiscal Policy:
- Definition: A neutral fiscal policy is one where government fiscal actions neither stimulate nor restrain the economy. It neither amplifies nor dampens the business cycle.
- Example: The government maintains a balanced budget, with neither excessive deficits nor surpluses.
- Impact: This policy does not directly influence the economic cycle but maintains fiscal stability.
- Goal: To ensure fiscal discipline without altering the direction of economic trends.