What role does fiscal policy play in an economy?

Fiscal policy plays a crucial role in an economy by stabilizing it through government spending and taxation. When the government adjusts its spending levels and tax rates, it can influence overall economic activity. For instance, during a recession, increased government spending can stimulate demand, leading to higher consumption and investment. Conversely, during periods of inflation, the government might reduce spending or increase taxes to cool down the economy.

This mechanism allows fiscal policy to address fluctuations in economic performance, aiming to achieve goals such as full employment and price stability. By influencing aggregate demand, fiscal policy can help smooth out the boom and bust cycles of the economy, fostering longer-term growth and stability.