Question

What is a counter-cyclical policy and why should it be used with fiscal policy?

Answer 1

The government has two types of fiscal policy - countercyclical(restrictive) and procyclical(expansory) policy. The government wants to avoid the economic recession and booms. To do this, it uses government spending and taxes. To kill an economic boom, it uses a restrictive, which is a countercyclical policy, by decreasing government spending and increasing taxes. On the other hand, to get rid of a recession the governemnt uses a expansory, which is a procyclical policy, by increasing the government spending and decreasing the taxes. Therefore, countercyclical policy is to kill the economic boom.

Counter-cyclical fiscal policies are those which act in the opposite way to the conventional economic cycle. These policies tends to cool down the economy when there is a boom and stimulate the economy when it is slow.

An example for counter cyclical policy is progressive taxation. In this system, the percentage of taxes on income increases with the rise of the economy. An increase in taxes tends to decrease demand, which helps to ensure that the rise in prosperity will not be too dramatic.

Counter cyclical fiscal policy can also address isolated issues in the economy. It can be used to attempt to prevent imbalances that can cause problems, such as when inflation outpaces unemployment. The goal is to maintain a certain output, which is affected by job growth, inflation, and the general health of the economy.