Fiscal policy uses government spending and taxation to influence aggregate demand.
Governments can increase demand by raising spending or reducing taxes, actions often described as expansionary fiscal policy. They can reduce demand by cutting spending or raising taxes, which is known as contractionary fiscal policy. The effects depend on economic conditions, timing, and how households and firms respond.
Fiscal policy is carried out through government budgets and legislation. It differs from monetary policy, which is generally conducted by a central bank through interest rates, money supply, or related tools. In many countries, elected governments and legislatures determine fiscal measures, while central banks operate monetary policy with varying degrees of independence.
Fiscal decisions also affect public borrowing and debt. A spending increase or tax reduction may support output during a downturn, but persistent deficits can raise financing costs or create longer-term sustainability concerns.