Fiscal Policy: How government decisions shape financial markets and your investments?

Government economic policy choices have a significant impact on global financial markets, including cryptocurrency prices. Fiscal policy – guiding the economy through taxes and government spending – is one of the most powerful tools governments use to stimulate growth, control inflation, and reduce unemployment. But how exactly does this policy system work in practice, and why should investors care?

The essence of fiscal policy: Taxes and government spending as economic drivers

Fiscal policy involves influencing the economy through taxation and government sector expenditures. It is a policy where governments decide how much of the national income is returned to the economy via taxes and government spending. By raising or lowering taxes and increasing or decreasing government expenditures, authorities can steer economic development in desired directions.

The key difference with fiscal policy is that it acts directly on households’ and firms’ national income. When people and corporations have more money in hand, they spend it on goods, services, and investments. This increased spending creates a ripple effect – more demand, more jobs, more activity.

The three main directions of fiscal policy

Fiscal policy is not just one approach but consists of three different types, chosen depending on the economic situation.

Neutral fiscal policy: Balance and stability

In neutral fiscal policy, the government maintains a balanced budget – expenditures equal revenues. This approach is typically chosen when the economy is functioning normally and sufficient growth has already been achieved.

For example, in 2019, Germany implemented neutral fiscal policy, keeping the federal budget balanced. The goal was to ensure sustainable economic development without incurring new debts. Think of a household with regular income and planned expenses – that’s the logic of neutral fiscal policy.

Expansionary fiscal policy: Stimulating the economy

Expansionary fiscal policy involves increasing government spending and reducing taxes. It is usually applied during economic downturns or high unemployment to pump more money into the economy.

During the 2008 financial crisis, the US government implemented massive expansionary fiscal measures. Tax incentives and direct financial aid to households left people with more disposable income. The result was increased consumption – people bought more, companies hired more workers, and the economy began to recover. This helped create jobs and restore economic growth.

Expansionary fiscal policy acts as a short-term boost to the economy, but long-term effects can be more complex – potential inflation and increased government debt.

Contractionary fiscal policy: Controlling inflation

Contractionary fiscal policy involves reducing government spending and increasing taxes to curb excessive growth and inflation.

In the early 1980s, the US government used contractionary measures to fight inflation. Taxes were raised, and government expenditures cut back. Less money circulated in the economy, consumer demand decreased, and price increases stabilized. The negative side was a temporary rise in unemployment, but it was the price paid to keep prices under control.

Fiscal policy and cryptocurrency markets: An indirect but significant connection

Although cryptocurrencies are designed to be independent of traditional financial systems, they are not immune to the effects of fiscal policy. Government decisions on taxes and spending alter the amount of money available to investors, which in turn influences demand for riskier assets, including cryptocurrencies.

Expansionary fiscal policy and crypto prices

When governments implement tax incentives and increase spending, more money remains in people’s hands. Some of this extra cash flows into cryptocurrencies. During the COVID-19 pandemic, many governments provided direct financial support to citizens. Many recipients used these funds to buy cryptocurrencies – Bitcoin, Ethereum, and other altcoins. This massive influx of income fueled rising crypto prices.

Simply put: more household money = greater capacity to invest in crypto = higher demand = higher prices.

Contractionary fiscal policy and crypto declines

Conversely, with increased taxes and reduced government spending, less money is available for investment. Funds that might otherwise have been used to sell crypto holdings are redirected toward consumption and essential expenses. Demand for cryptocurrencies drops, and prices follow suit.

Thus, there is a direct link: expansionary policies support crypto prices, contractionary policies exert downward pressure.

Additional tools: Government stimulus packages

During crises, countries have used direct stimulus measures. These are not typical tax-and-spend policies but direct transfers of cash to citizens. During COVID-19, the US, European countries, and others sent direct financial aid. Some of this money flowed into cryptocurrencies, contributing to the crypto bubble of 2020–2021.

Advantages and strengths of fiscal policy

Economic stability and growth

Fiscal policy can stabilize the economy, especially during downturns. Expansionary measures help reduce unemployment and promote growth, while contractionary policies curb inflation.

Public services and infrastructure

Through tax collection, governments fund critical infrastructure and public services. For example, Sweden invests heavily in healthcare and education using progressive taxation. China’s Belt and Road Initiative improved regional transportation infrastructure and boosted trade.

Wealth redistribution

Fiscal policy allows governments to reduce inequality by redistributing wealth. Higher taxes on high incomes fund support for lower-income populations.

Limitations and challenges of fiscal policy

While powerful, fiscal policy has limitations. Increased government spending leads to higher debt – expansionary policies can result in long-term debt accumulation. Also, economic effects are not immediate; policy impacts materialize over time, making timely responses challenging.

Summary: Why fiscal policy matters to investors

Fiscal policy is a system of government decisions that directly influence the cash flows of individuals and businesses. Choices about taxes and government spending, in turn, affect financial markets, including crypto markets. Expansionary policies support consumption and investment, including in cryptocurrencies. Contractionary policies restrict spending and can put downward pressure on risky assets.

Investors monitoring economic policy and government budget actions can better anticipate market movements and make informed investment decisions. Fiscal policy is not just a theoretical concept – it is a real force shaping investment returns.