Government policies and actions often influence the economy of the country. Fiscal expansion, also known as fiscal stimulus, is one common way a government can affect economic growth. During times of economic stagnation, fiscal expansion enables the government to encourage growth by changing the levels of spending or taxation.
Fiscal expansion is generally defined as an increase in economic spending owing to actions taken by the government. This expansion of spending in the economy may be intended, or may be a side effect of a government policy. Government spending is limited by its budget and available funds. Factors such as tax levels and national budgets can affect how much fiscal expansion can occur.
There are two basic causes of fiscal expansion. The first is increased government spending directly into the economy. For instance, if the government begins an expensive new highway project, direct fiscal expansion occurs when money is spent to buy the necessary equipment and hire workers. The second cause of fiscal expansion is decreasing taxes. When taxes decrease, people are able to keep and spend more of their money. The increased spending by consumers leads to indirect fiscal expansion.
The primary advantages of fiscal expansion are increased economic stimulus and expanded demand for goods and services. Theoretically, fiscal expansion enables companies to increase their output and hire more workers. Fiscal expansion is sometimes used to "jump-start" a stagnant economy and increase the productivity of private businesses.
Fiscal expansion that depends on government spending can lead to a budget deficit. A deficit occurs when the government increases spending beyond the level of incoming revenue. Long-term deficit spending can drain the financial reserves of the government. Expansion that relies on tax cuts can also create disadvantages. If the government lowers taxes too far, it may not bring in enough yearly revenue to meet its obligations. For these reasons, government fiscal expansion is usually used as a short-term strategy, and cannot be used to grow the economy indefinitely.