Last Updated on: 3rd February 2021, 05:53 pm
Fiscal policy, or financial policy, is the method by which governments adjust their levels of spending and taxation to directly influence the economy. Fiscal policy goes hand in hand with monetary policy (the means by which central banks influence money supply) to achieve various economic goals.
Financial policy has gained popularity during the 1930s after it had been advocated by British economist John Maynard Keynes. He suggested that whenever a nation is in recession, putting more money in the hands of consumers could lead to economic growth. This could be done by reducing taxes or increasing government spending.
Various Fiscal Policies
The following are the three basic financial policies: neutral, expansionary, and contractionary.
Neutral – Government spending is roughly equal to its revenue.
Expansionary – Government spending is higher than its revenue.
Contractionary – Government spending is lower than its revenue.
Effects of Fiscal Policies on Exchange Rates
The effect of fiscal policy on the currency is highly dependent on the economic situation. Since each country is unique and the economic environment is constantly changing, it is very hard to tell exactly how fiscal policy will affect exchange rates.
Let’s say a government has a budget deficit due to an expansionary fiscal policy. To finance the deficit, the government can work with the central bank to print fresh currency (also known as quantitative easing).
The newly printed money can be used by the government in their economic development projects. The increase in money supply can end up being inflationary and lead to the weakening in the value of the domestic currency in relation to foreign currencies.
Vincent Nyagaka is a Professional Trader, Analyst & Author. He has been actively engaged in market analysis for the past 7 years. He has a monthly readership of 100,000+ traders and has taught over 1,000 students since 2014. Vincent is also an experienced instructor and public speaker. Check out Vincent’s Professional Trading Course here.