Key points:

  • Fiscal policy refers to how governments use taxation and government spending to influence economic conditions, including unemployment, inflation, and economic growth.

  • It is a tool that allows the government to steer the economy in a desired direction by influencing the disposable income of individuals and companies, which indirectly affects financial markets.

  • Fiscal policy is used by governments to finance various public services, such as education and healthcare. It also ensures economic stability and cushions the negative aspects of both economic booms and busts.

Introduction

Economic stability and growth are key to the prosperity of countries. Governments can help achieve these goals by using various tools to influence economic conditions. The main objectives of fiscal policy include achieving economic stability, promoting economic growth, and redistributing wealth.

In this article, we will look at how fiscal policy works, how it can affect cryptocurrency markets, and some of its benefits and challenges.

What is fiscal policy?

Fiscal policy is the use of taxes and government spending to influence the economy. By adjusting taxes and government spending, governments can control inflation, create jobs, and promote economic growth.

How does fiscal policy work?

There are three types of fiscal policy: neutral, expansionary, and contractionary.

Neutral fiscal policy

Neutral fiscal policy involves maintaining a balanced budget, meaning that the amount the government spends is equal to the amount it earns. It is typically used to maintain economic stability and avoid any additional interventions.

Imagine Country A as a household run by Alice and Bob. They carefully plan their monthly income and expenses to ensure that they spend exactly what they earn. If Alice earns $1,000 and Bob earns $1,000, they plan their monthly expenses to be $2,000. This illustrates how government spending and revenue can be balanced under a neutral fiscal policy, ensuring economic stability.

Example

In 2019, Germany pursued a neutral fiscal policy, maintaining a balanced budget. It was aimed at ensuring economic stability and avoiding new debt.

Expansionary fiscal policy

Expansionary fiscal policy involves increasing government spending and reducing taxes to stimulate economic growth. This is typically implemented during a recession or periods of high unemployment. The goal is to increase consumer and business spending, which can lead to job creation and increased economic activity.

Imagine that the government of Country B plans to stimulate the economy by cutting taxes. Alice and Bob, residents of Country B, suddenly realize that they have more money to spend. Alice uses her extra money to renovate her house, and Bob buys a new computer. The demand for goods and services increases, creating more jobs and boosting economic activity.

Example

During the 2008 financial crisis, the U.S. government pursued expansionary fiscal policy to revive the economy. Tax cuts were introduced to reduce the tax burden on many households. This allowed people to save more of their income, which led to increased spending.

Increased spending led to a rise in demand for goods and services, which prompted businesses to hire more workers. Along with the increase in employment, people had more money, which further stimulated economic activity and supported the economic recovery.

Constraining fiscal policy

Fiscal policy involves cutting government spending and raising taxes to slow economic growth and combat inflation. By taking money out of the economy, the government aims to reduce aggregate demand, which can help lower prices.

Imagine that the government of country B wants to slow inflation by raising taxes. As a result, Alice and Bob, residents of country B, find that they have less money to spend. Alice decides to postpone her plans to buy a new car, and Bob cancels his planned purchases. Consumer demand falls, and companies see sales decline. This helps cool the economy and control price increases.

Example

In the early 1980s, the U.S. government used contractionary fiscal policy to combat inflation. They raised taxes and cut government spending to slow the economy. The decline in aggregate demand helped stabilize prices. However, it also led to a temporary increase in unemployment as businesses faced higher taxes and reduced consumer spending.

Fiscal policy in cryptocurrency

Fiscal policy can also affect financial markets, particularly the cryptocurrency market. While cryptocurrencies can operate independently of traditional markets, changes in fiscal policy can significantly affect the value of cryptoassets.

The impact of expansionary fiscal policy

When a government implements expansionary fiscal policy, more money flows into the economy. This extra money leads to increased consumer spending and investment as people have more disposable income. In the context of cryptocurrencies, this means that the population is more likely to buy cryptocurrency, which can potentially drive up prices.

Example

Suppose Alice receives a tax cut that gives her additional disposable income. She decides to invest some of this extra money in bitcoin and ether. As more people like Alice invest their extra disposable income in cryptocurrency, the demand for crypto assets increases. With sufficient demand and volume, market prices tend to rise.

The impact of restrictive fiscal policy

When a government implements a contractionary fiscal policy, money is withdrawn from the economy, leading to lower consumer spending and investment. This means that people have less disposable income to invest in cryptocurrency, which can potentially drive down prices.

If Alice faces a tax increase, she will have less money to spend or invest. So, she may decide not to buy more bitcoin or ether. With fewer people investing in cryptocurrency, demand falls, which can lead to lower or stagnant prices.

The impact of government incentives

Government stimulus, a form of expansionary fiscal policy, can also have an impact on cryptocurrency markets. For example, during the COVID-19 pandemic, many governments offered financial assistance to their citizens. Some recipients used the money to invest in cryptocurrency, which contributed to a sharp increase in cryptocurrency prices.

Advantages of fiscal policy

Economic stability

Fiscal policy can stabilize the economy by controlling inflation and reducing unemployment. Expansionary fiscal policy can stimulate growth and create jobs during economic downturns, while contractionary fiscal policy can help control inflation during economic booms.

Improved infrastructure

Increased government spending can improve infrastructure, leading to improved transportation systems and telecommunications. For example, China's investment in the Belt and Road Initiative (BRI) has improved its transportation infrastructure, boosting trade and economic growth.

Free government services

By taxing higher incomes at higher rates, governments can fund various public services. For example, Sweden uses progressive taxation to offer free healthcare and higher education, allowing people to access them regardless of their income level.

Results

Fiscal policy refers to the use of taxation and government spending to influence various economic conditions, such as inflation, unemployment, and economic growth. Since fiscal policy affects the disposable income of individuals and companies, it also indirectly affects the cryptocurrency market. Some of its benefits include economic stability, improved infrastructure, and free government services.

Disclaimer: This content is provided to you "as is" for general information and educational purposes only, without any representations or warranties of any kind. It should not be construed as financial, legal, or other professional advice, and is not intended to be a recommendation to purchase any specific product or service. You should consult your appropriate professional advisors for advice. If the article is written by a third-party author, please note that the opinions expressed are those of the third-party author and do not necessarily reflect the views of Binance Academy. For more information, please see our disclaimer . The prices of digital assets can be volatile. The value of your investments may fall as well as rise, and you may not get back the amount you invested. You are solely responsible for your investment decisions, and Binance Academy is not liable for any losses you may incur. This material should not be construed as financial, legal, or other professional advice. For more information, please review our Terms of Use and Risk Warning.