Fiscal Policy Explained: Taxes, Spending, and the Economy
Governments influence the economy through how much they tax and spend.
By Iris Penhaligon | Sep 26, 2026 | 6 min
Fiscal policy is the use of government spending and taxation to influence the economy.
It works alongside monetary policy, set by central banks.
I Expansionary policy
Increasing spending or cutting taxes boosts demand, useful in recessions. It can increase borrowing.
II Contractionary policy
Cutting spending or raising taxes reduces demand, which can help cool inflation or reduce deficits.
III Automatic stabilisers
- — Unemployment benefits rise in downturns
- — Tax revenues fall as incomes fall
- — These cushion the economy without new decisions
IV Debates
Economists debate the size of fiscal multipliers, the risks of high debt, and timing. See our recession and central banks guides.
V Government debt and deficits
A budget deficit is when a government spends more than it collects in a year; debt is the total accumulated borrowing. Running deficits in downturns is common and can support the economy, but persistent large deficits raise debt levels and interest costs. How much debt is sustainable depends on interest rates, economic growth, and whether debt is in the country’s own currency. Economists disagree on the right levels, which is why fiscal policy is often politically contested.
This is general educational information about economics, not financial, investment, or tax advice. Consult a qualified, licensed professional before making financial decisions.
Further reading
- 1. Supply Chains: Why Disruptions Ripple Through the Economy
- 2. What Do Central Banks Actually Do?
- 3. What Causes Inflation? A Plain-English Guide