Fiscal Policy: How the Government Shapes the Economy

Fiscal policy is one of the most important tools of government, allowing influence over economic conditions and regulation of the country’s financing. Through tax and budget policies, governments can control inflation, reduce unemployment, promote economic growth, and ensure financial stability. This mechanism operates through individuals’ and businesses’ disposable income, indirectly affecting financial markets, including the cryptocurrency sector.

How Fiscal Policy Is Defined and How It Works

Fiscal policy involves government decisions regarding tax levels and the allocation of government spending. By regulating these two main parameters, the state can steer the economy in the desired direction. When the government increases or decreases taxes, or adjusts the budget distribution among different sectors, it directly affects how much money remains available to households and businesses.

This government intervention does not only impact direct income. Fiscal policy shapes the overall economic environment, creating new business opportunities or additional barriers. Through education, healthcare, and infrastructure projects, the government creates conditions for long-term economic growth.

The Three Main Forms of Fiscal Policy

Economists distinguish three main forms of fiscal policy, which differ in their goals and methods.

Neutral Fiscal Policy

Neutral fiscal policy means that the government spends as much as it receives from taxes and other revenue sources. The goal of this budget balance is to avoid additional economic disruptions and maintain stability.

For example, a household balances its monthly expenses with its income—if Family A receives 2000 euros per month, it plans to spend roughly that amount. Similarly, the government may aim for the country’s budget revenues and expenditures to be aligned. In 2019, Germany adhered to this strategy, maintaining a balanced budget and avoiding new debts. Such fiscal policy provides stability but may not offer enough stimulus for economic growth during a downturn.

Expansionary Fiscal Policy

Expansionary fiscal policy is a deliberate government choice to boost the economy by reducing taxes and increasing government spending. It is typically applied during economic recessions or periods of high unemployment when the economy lacks vitality and needs to stimulate consumer demand.

When the government lowers taxes, people and businesses are left with more money. This additional amount creates enormous economic energy—people use it for home renovations, new purchases, and businesses for expansion and hiring. During the 2008 global financial crisis, the US implemented aggressive expansionary policies. The government cut taxes for many families and increased its budget expenditures. The direct result was that people had more money to spend on goods and services, which encouraged entrepreneurs to hire additional workers. This increase in employment generated further income and strengthened the economic recovery.

However, expansionary fiscal policy also carries risks—if not applied carefully, it can lead to increased government debt and create new economic imbalances.

Contractionary Fiscal Policy

Contractionary fiscal policy is the opposite government choice: it increases taxes and reduces its expenditures. This strategy aims to slow down the economy and combat high inflation. By removing money from the economy (through higher taxes) and reducing government demand (through lower spending), the government attempts to decrease overall price pressures.

A representative example is the early 1980s in the US, which faced runaway inflation. The government increased taxes and drastically cut government spending. The economy slowed, but price stability was achieved. The side effect of this policy was an increase in unemployment—when people had to pay more taxes and the government spent less, business activity declined, and jobs were lost.

Interaction Between Cryptocurrency Markets and Fiscal Policy

Although cryptocurrencies are often viewed as independent of traditional economic forces, changes in fiscal policy have a tangible impact on the value of crypto assets and market dynamics.

Expansionary Fiscal Policy Stimulates Cryptocurrency Demand

When the government implements expansionary fiscal policy, the economy receives an influx of money. These funds, which end up in people’s and businesses’ accounts, create investment opportunities. Some investors, seeking diversification and growth potential, turn to cryptocurrencies.

In a specific example: if the government provides a tax credit and individuals receive an extra 500 euros, some decide to invest this money in Bitcoin or Ethereum. When many do so, cryptocurrency demand increases exponentially. Based on the law of supply and demand—when demand rises and supply is limited—cryptocurrency prices tend to jump upward.

Contractionary Fiscal Policy Restricts Investment

Conversely, when the government adopts contractionary fiscal policy with higher taxes, people have less disposable income or choose to reallocate it. Instead of risky investments like cryptocurrencies, they may prefer safer alternatives—bank savings or bonds.

If Alice has to pay an additional 200 euros in taxes, she might postpone her plans to buy Ethereum or Bitcoin. When thousands or millions of people make similar decisions, demand for cryptocurrencies drops sharply, often leading to price declines.

Government Stimulus Programs and Their Actual Impact

Government stimulus packages, as a form of expansionary fiscal policy, have a direct effect on cryptocurrency markets. During the COVID-19 pandemic in 2020-2021, many countries (US, EU member states, Canada, Australia) issued massive stimulus packages, directly transferring money to citizens. These funds, partly used for investments in cryptocurrencies, contributed to a record rise in the crypto market.

Fiscal Policy’s Impact on the Country’s Economy

Economic Stability and Growth

Properly targeted fiscal policy can provide stability to the economy. Expansionary policies during economic crises can halt collapse and initiate growth, while contractionary policies during overheating can prevent inflation and maintain consistency.

Infrastructure Development

Governments that allocate budget spending to infrastructure projects aim for long-term economic results. China’s “Belt and Road Initiative” (BRI) is a massive example of fiscal policy—investing hundreds of billions of dollars into transportation infrastructure, railways, and ports across Asia, Africa, and other regions. These investments not only improved China’s transportation capabilities but also established new trade routes and spurred regional economic growth.

Funding Public Services

Progressive tax systems, where higher-income individuals pay a larger share, enable governments to finance free or affordable public services. Sweden exemplifies this model—its progressive tax system allows the country to offer free healthcare, free higher education, and high social protection levels. These services improve people’s quality of life regardless of income level.

Final Thoughts

Fiscal policy is not an abstract academic concept—it is a concrete government tool shaping our daily economic reality. Through tax and budget decisions, governments control inflation, create jobs, and stimulate or slow economic growth.

Particularly notable is the impact of fiscal policy on cryptocurrency markets, where expansionary policies generally boost demand, and contractionary policies tend to suppress it. Investors who understand how government decisions influence economic conditions can better forecast market movements.

While fiscal policy offers significant benefits—economic stability, infrastructure development, and funding public services—it is not a cure-all. The most effective results are achieved when fiscal policy is balanced, cautious, and tailored to specific economic challenges. Therefore, if you want to understand why markets jump and cryptocurrency prices fluctuate, look at government budget decisions—they often hold the answer.