We are independent & ad-supported. We may earn a commission for purchases made through our links.
WiseGeek
Advertiser Disclosure
Our website is an independent, advertising-supported platform. We provide our content free of charge to our readers, and to keep it that way, we rely on revenue generated through advertisements and affiliate partnerships. This means that when you click on certain links on our site and make a purchase, we may earn a commission. Learn more.
How We Make Money
We sustain our operations through affiliate commissions and advertising. If you click on an affiliate link and make a purchase, we may receive a commission from the merchant at no additional cost to you. We also display advertisements on our website, which help generate revenue to support our work and keep our content free for readers. Our editorial team operates independently of our advertising and affiliate partnerships to ensure that our content remains unbiased and focused on providing you with the best information and recommendations based on thorough research and honest evaluations. To remain transparent, we’ve provided a list of our current affiliate partners here.
Business

Our Promise to you

Founded in 2002, our company has been a trusted resource for readers seeking informative and engaging content. Our dedication to quality remains unwavering—and will never change. We follow a strict editorial policy, ensuring that our content is authored by highly qualified professionals and edited by subject matter experts. This guarantees that everything we publish is objective, accurate, and trustworthy.

Over the years, we've refined our approach to cover a wide range of topics, providing readers with reliable and practical advice to enhance their knowledge and skills. That's why millions of readers turn to us each year. Join us in celebrating the joy of learning, guided by standards you can trust.

What Is the Relationship between Fiscal Policy and Interest Rates?

Esther Ejim
By
Updated: May 17, 2024
Views: 6,896
References
Share

Fiscal policies are economic tools utilized by government to manipulate the level of total demand for final goods and services in an economy. Interest rates are one of the economic factors used to influence the rate of consumption by consumers. Fiscal policies relating to interest rates may either be expansionary or aimed toward the contraction of demand for goods and services.

In most basic terms, fiscal policy is government spending and taxation. How much the government decides to spend and tax rates, make up the government's fiscal policy. When government spending is less than government revenue, it is said that a contractionary fiscal policy is in place. If the government is spending more than the revenue, it is said to be engaging in expansionary fiscal policy.

There is general consensus among economists that fiscal policies may and often do have an effect on interest rates. However, there are differing opinions on what this effect is, the significance of the effect and how different factors impact the relationship. One of the most prevalent ideas about the relationship between fiscal policies and interest rates is that fiscal expansion raises interest rates. So when the government is spending more than its revenue, interest rates will go up.

A 2013 IMF working paper found that fiscal policy, together with global monetary policy, account for more than 60% of variances in long-term interest rates. Those who carried out this study argue that the relationship between national fiscal policy and interest rates is weaker if one does not count for global fiscal factors. Another paper, written by the Research Institute of Applied Economics in 2008, argues that large deficits have significant effects on interest rates but some factors like spillover reduces these effects.

Economists continue to study the relationship between fiscal policy and interest rates. It is important to better understand this relationship because it can assist economists and policy makers to develop better fiscal policies, as well as estimate more accurately the consequences of current policies.

Share
WiseGeek is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.
Link to Sources
Esther Ejim
By Esther Ejim
Esther Ejim, a visionary leader and humanitarian, uses her writing to promote positive change. As the founder and executive director of a charitable organization, she actively encourages the well-being of vulnerable populations through her compelling storytelling. Esther's writing draws from her diverse leadership roles, business experiences, and educational background, helping her to create impactful content.
See our Editorial Process Share Feedback

Editors' Picks

Related Articles

Discussion Comments
By bluedolphin — On Jan 26, 2014

@literally45-- That's only true in countries where there is a free market and where the free market determines interest rates. In some countries, the government decides the interest rate through fiscal policies, regardless of other economic factors.

By fify — On Jan 26, 2014

@literally45-- You're right. Government doesn't directly decide on interest rates, but the Federal Reserve is also a government agency. And how the Federal Reserve manages the economy has a lot to do with fiscal policies. What the Federal Reserve does is called monetary policy. Monetary policies are used foremost to deal with issues like low interest rates and high inflation. But when these policies fail, government will use discretionary fiscal policies to directly or indirectly change the direction of the economy.

The government may indirectly cause higher interest rates. For example, if the government predicts that the economy is heading towards recession and increases spending or lowers taxes, it will stimulate the economy. But if the global economy is not doing well, interest rates will probably increase.

By literally45 — On Jan 25, 2014

I don't think there is much of a connection between fiscal policy and interest rates, aside from the fact that the government keeps an eye on interest rates.

Interest rates are determined by the Federal Reserve in the United States. They decide whether to raise them or decrease them. Fiscal policies are decided on by Congress. They decide on taxes and government spending by evaluating the state of the economy. But fiscal policy doesn't determine interest rates.

Hot Topics
WiseGeek,
in your inbox
Our latest articles, guides,
and more, delivered daily.
Follow us:
Esther Ejim
Esther Ejim
Esther Ejim, a visionary leader and humanitarian, uses her writing to promote positive change. As the founder and...
Learn more
Share
https://www.wisegeek.net/what-is-the-relationship-between-fiscal-policy-and-interest-rates.htm
Copy this link
WiseGeek, in your inbox

Our latest articles, guides, and more, delivered daily.

WiseGeek, in your inbox

Our latest articles, guides, and more, delivered daily.