Fiscal policy and its role in the modern economy

Governments utilize various economic instruments to manage the country’s economy and achieve important social goals. One of the most significant of these instruments is fiscal policy, which affects tax systems and the level of public spending. Understanding how fiscal policy works helps informed citizens evaluate policymakers’ decisions and their potential impact on personal finances and investment opportunities.

The Essence of Fiscal Policy: Taxes and Government Spending

Taxation and government budget allocations are two primary sources of fiscal policy. These two elements shape how governments control economic activity and allocate resources. In other words, fiscal policy is a mechanism through which governments alter the country’s economic environment, directly influencing household and business sector incomes and expenditures.

When the government reduces taxes, citizens and businesses have more disposable income. These additional funds are typically directed toward consumption or investment, leading to increased economic activity. Conversely, higher tax rates or reduced public spending decrease the amount of free money in the economy, often slowing growth. Governments use these instruments to curb inflation, reduce unemployment, and promote long-term economic growth.

Three Fiscal Policy Models and Their Economic Effects

Economists generally classify fiscal policy into three main types depending on the economic situation and policymakers’ goals. Each model has a different level and produces opposite effects in the economy.

Balanced Fiscal Policy: Seeking Stability

Balanced or neutral fiscal policy means the government spends the same amount of money as it collects through taxes. This model is used when the economy is functioning normally and no additional intervention is needed. The government aims to ensure economic stability, avoiding borrowing and preventing excessive inflation.

For example, in 2019, Germany adopted a balanced budget principle, not increasing new debt. This allowed the country to maintain a stable economic position without fueling inflation issues. This approach is excellent for long-term periods but may be ineffective during economic crises.

Expansionary Fiscal Policy: Stimulating Growth During Recession

When the economy experiences a recession or high unemployment, governments often implement expansionary — also called stimulative — fiscal policy. This involves increasing public spending and decreasing taxes to inject additional money into the economy.

During the 2008 global financial crisis, the United States implemented massive stimulus programs. The government lowered taxes for many households and increased infrastructure projects. These measures allowed households and businesses to have more funds for spending and investment. As demand increased, the supply of labor grew, and the economy gradually regained growth momentum. Expansionary fiscal policy acts as an “economic stimulator,” but over time it can increase national debt.

Contractionary Fiscal Policy: Controlling Inflation

When the economy overheats and inflation rises rapidly, governments take the opposite route — contractionary fiscal policy. Here, the government reduces public spending and raises taxes to withdraw excess money from the economy.

In the early 1980s, the United States experienced extremely high inflation. The government decided to adopt a strict contractionary policy: raising taxes and cutting public expenditures. While this eventually controlled prices, in the short term it increased unemployment as businesses faced smaller budgets and consumers reduced spending. Contractionary policy is appropriate during moderate or rapid inflation but can cause social discomfort.

How Fiscal Policy Shapes the Cryptocurrency Market

Although cryptocurrencies are often seen as an alternative to traditional financial systems, they are also affected by changes in fiscal policy. The modern crypto ecosystem is closely linked to macroeconomic factors that influence it through household disposable income.

Stimulative Spending and Demand for Bitcoin

When governments inject money directly into the economy via stimulus packages, average investors have more funds. Some of these investors choose to allocate part of their money into crypto portfolios. This increases demand for Bitcoin, Ethereum, and other cryptocurrencies.

During the COVID-19 pandemic, many governments, including the United States and European countries, issued massive stimulus payments to their citizens. Some of these funds entered the crypto market, contributing to the price surge of cryptocurrencies in 2020–2021. This demonstrates how fiscal policy can have an indirect but significant impact on alternative investment markets.

Contractionary Policy and Reduced Crypto Appetite

When governments implement contractionary policies, average citizens have less disposable income. Currently, demand for risky investments like cryptocurrencies decreases as people shift their portfolios toward more conservative assets. As the severity of restrictive policies increases, the crypto market typically declines due to reduced speculative demand.

Government Borrowing and Changes in Investment Climate

The debt accumulated through fiscal policy often influences long-term interest rates and inflation. If a government significantly increases debt during stimulus periods, investors may expect higher inflation. In such an environment, cryptocurrencies, especially Bitcoin, which is often viewed as an inflation hedge, become more attractive. Conversely, if the government reduces debt, investors may focus on less risky assets.

Benefits of Fiscal Policy and Real-World Examples

Properly applied fiscal policy can have profound positive effects on society and the economy.

Social Stability and Unemployment Reduction

One of the main advantages of fiscal policy is its ability to reduce unemployment and create new jobs. Public investments in infrastructure, education, and healthcare directly lead to job creation. This is especially important during economic downturns when the private sector cannot fulfill this role.

Infrastructure Development and Long-Term Growth

Governments that use fiscal policy to invest in infrastructure often generate long-term economic benefits. For example, China’s Belt and Road Initiative has partly financed infrastructure development, improving transportation links, boosting trade, and fostering economic integration. Similar projects create jobs and increase a country’s competitiveness in the global market.

Free Services and Living Standards Improvement

A progressive tax system, where higher-income individuals pay more, allows governments to fund public services accessible to all. Sweden exemplifies this model: by applying progressive taxes, it can provide free higher education and healthcare to all residents, regardless of income. This increases social mobility and improves living standards.

Inflation Control and Preservation of Money’s Value

While contractionary fiscal policy may cause short-term discomfort, it is necessary to combat unwanted inflation. By reducing economic overheating, governments protect citizens’ savings from devaluation and maintain the value of money.

Key Conclusions on Fiscal Policy

Fiscal policy is a complex but valuable tool for governments to manage the economy and care for their citizens. Depending on the chosen model — balanced, stimulative, or contractionary — fiscal policy can have different effects: from promoting economic growth to controlling inflation and creating jobs.

In today’s world, where cryptocurrencies and alternative financial markets exist, the influence of fiscal policy is also reflected in these modern financial spheres. Household incomes directly affected by fiscal policy determine their spending, saving, and investment decisions, including those related to cryptocurrencies. Understanding these relationships helps citizens better forecast economic trends and make informed financial decisions for their personal situations.