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Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy. It is the sister strategy to monetary policy through which a central bank influences a nation's money supply. These two policies are used in various combinations to direct a country's economic goals. Here's a look at how fiscal policy works, how it must be monitored, and how its implementation may affect different people in an economy.

Before the Great Depression, which lasted from October 29, 1929, to the onset of America's entry into World War II, the government's approach to the economy was laissez-faire. Following World War II, it was determined that the government had to take a proactive role in the economy to regulate unemployment, business cycles, inflation, and the cost of money. By using a mix of monetary and fiscal policies (depending on the political orientations and the philosophies of those in power at a particular time, one policy may dominate over another), governments can control economic phenomena.

Instruments of Fiscal Policy:

The tools of fiscal policy are taxes, expenditure, public debt and a nation’s budget. They consist of changes in government revenues or rates of the tax structure so as to encourage or restrict private expenditures on consumption and investment.

Public expenditures include normal government expenditures, capital expenditures on public works, relief expenditures, subsidies of various types, transfer payments and social security benefits.

Government expenditures are income-creating while taxes are primarily income-reducing. Management of public debt in most countries has also become an important tool of fiscal policy. It aims at influencing aggregate spending through changes in the holding of liquid assets.

During inflation, fiscal policy aims at controlling excessive aggregate spending, while during depression it aims at making up the deficiency in effective demand for raising the economy from the depths of depression. The following considerations may be noted in the adoption of proper policy instruments.

A Contra cyclical Budgetary Policy:

The policy of managed budgets implies changing expenditures with constant tax rates or changing tax rates with constant expenditures or a combination of the two. Budget management may be used to tackle depression and inflationary situations. Deliberate attempts are made under this policy to adjust revenues, expenditures and public debt to eliminate unemployment during depression and to achieve price stability in inflation.

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