Fiscal policy and its impact on the economy and crypto-assets

Basic Principles

Fiscal policy is a mechanism of government management that operates through the regulation of tax burdens and the levels of government funding. In practice, this means that government bodies manage the distribution of money in the economy, influencing unemployment levels, price stability, and rates of economic growth.

When the government modifies tax rates and reallocates budget expenditures, it exerts an indirect influence on financial markets, including the digital asset market. This happens because such decisions affect the amount of disposable funds available to individuals and companies.

The third aspect of fiscal policy lies in its function of financing public services and maintaining economic stability. The state ensures the functioning of educational institutions, medical establishments, and also mitigates the effects of both periods of economic growth and decline.

Three Approaches to Fiscal Policy

Balanced approach

A balanced fiscal policy involves aligning expenditures with revenues. The state spends exactly as much as it receives, refraining from accumulating debt obligations.

The allegory of household management illustrates this approach well. Think about a family that plans its monthly expenses according to its income. If both family members together earn 2000 dollars, they plan their expenditures based on this amount, avoiding excessive spending.

In 2019, a similar balance was maintained by Germany, trying to avoid the accumulation of public debt and ensure macroeconomic stability.

Stimulating approach

During economic crises and periods of high unemployment, governments often resort to expanded financing and tax incentives. The stimulative approach to fiscal policy involves increasing spending and lowering taxes to ignite economic activity.

The mechanism works as follows: citizens receive more money in the form of tax reductions. With the additional disposable income, people will purchase more goods and services. When demand for goods increases, producers expand production and hire additional workers. Employment rises, wages increase, and the economy gains new momentum.

A classic example: in 2008, during the global financial crisis, the U.S. government implemented tax breaks for households. People saved more money and began to spend more actively. Demand for goods and services rose, prompting companies to hire anew. This chain reaction allowed the economy to recover.

Constraining approach

When inflation gets out of control, the state often resorts to the opposite strategy — curbing expenditures and increasing taxes. This reduces the amount of free money in the hands of the population and companies, lowers overall demand, and stuns inflationary processes.

Mechanism: the government raises taxes. Households and businesses have less money. Consumption decreases. Companies observe a decline in sales and cut expenses. As a result, the economy cools down and the growth of prices slows.

Example: In the early 1980s, the United States implemented a restrictive fiscal policy to combat double-digit inflation. Taxes were raised, and spending was cut. Inflation did indeed fall, but temporary unemployment rose as businesses faced a contraction in consumer spending.

Fiscal Policy and Crypto-Assets: Specifics of the Interconnection

Although cryptocurrency markets are often positioned as independent from traditional economic factors, in reality, fiscal policy has a significant impact on the value of digital assets.

When the state expands funding

Expansionary fiscal policy means that more money is circulating in the economy. People have higher disposable income and are looking for ways to invest it. Part of this money is directed towards purchasing cryptocurrencies.

Suppose a citizen received a tax discount and got an additional 500 dollars. Part of it he decides to invest in bitcoin and ethereum. When there are many such individuals at the same time, the demand for crypto-assets increases, which puts pressure on prices upwards.

Government incentives provided during the COVID-19 pandemic have become a striking example. Many governments distributed direct payments to citizens. Some recipients invested this money in cryptocurrencies, which led to a significant increase in the prices of digital assets during 2020-2021.

When the state restrains expenditures

Opposite situation: the government raises taxes and cuts expenditures. Citizens have less money. The incentive to invest in crypto assets weakens. Demand decreases, prices may fall or stagnate.

If the same person who received the tax benefit now loses $500 due to the tax increase, they are unlikely to rush to invest in cryptocurrencies. With the number of buyers decreasing, supply outweighs demand, and prices fall.

Positive Aspects of Fiscal Policy Implementation

Ensuring macroeconomic equilibrium

Properly directed fiscal policy smooths out economic fluctuations. During downturns, it stimulates activity, while during overheating, it cools down growth. This helps keep inflation within acceptable limits and maintains unemployment at an acceptable level.

Infrastructure Development

Increased government expenditures can be directed towards the development of the transportation system, energy sector, and communications. Such investments contribute to long-term economic growth. An example is the large-scale infrastructure projects in China that stimulated domestic and international trade.

Guaranteeing access to basic services

Through progressive taxation, the state can subsidize education and healthcare, making them accessible regardless of citizens' income. For example, in Sweden, high taxes on wealthy individuals fund free healthcare and higher education for all.

Concluding Remarks

Fiscal policy is a powerful tool of state regulation that affects tax burdens and the volumes of government funding. Since it determines the amount of free money in the economy, it indirectly influences the crypto-asset markets.

Understanding the mechanisms of fiscal policy helps investors anticipate fluctuations in demand for digital assets and make informed decisions. At the same time, governments use this tool to achieve macroeconomic balance, develop infrastructure, and ensure social well-being.