Fiscal Policy

Fiscal policy refers to the approach taken by governments to modify their spending and taxation levels in order to directly impact the economy. It works in conjunction with monetary policy, which is the method used by central banks to manage the money supply, to achieve various economic objectives.

Fiscal policy became widely recognized in the 1930s, largely due to the advocacy of British economist John Maynard Keynes. He proposed that during a recession, increasing the amount of money available to consumers could stimulate economic growth. This could be accomplished through tax reductions or increased government spending.

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

• Neutral: Government spending is approximately equal to its revenue.
• Expansionary: Government spending exceeds its revenue.
• Contractionary: Government spending is less than its revenue.

The impact of fiscal policy on currency values is highly influenced by the specific economic context. Given that each country has its own unique circumstances and that the economic landscape is continually evolving, it is challenging to predict precisely how fiscal policy will affect exchange rates.

For instance, if a government is running a budget deficit due to an expansionary fiscal policy, it may collaborate with the central bank to create new currency, a process known as quantitative easing. The newly generated funds can be utilized by the government for economic development initiatives. However, an increase in the money supply can lead to inflation, which may result in a depreciation of the domestic currency against foreign currencies.