How Fiscal Policy Reshapes the Economy and the Crypto Market

Opening Thoughts

Economic growth and stability do not come for free. Whenever the government adjusts taxes or changes spending directions, the market reacts - from stocks to real estate, even cryptocurrencies are not spared. Fiscal policy as the government's most direct economic tool is shaping the decisions of global investors. So how does this mechanism work? What does it mean for crypto assets?

The Core Mechanism of Fiscal Policy

Fiscal policy refers to the way the government influences the economy by adjusting taxes and spending. By changing the level of taxation and the scale of government spending, decision-makers can control inflation, create job opportunities, and promote economic growth. In simple terms, it's like the accelerator and brake of a car—pressing the accelerator stimulates growth, while pressing the brake cools down an overheated economy.

Government spending is directly related to the financing of public services such as education, healthcare, and infrastructure. Each decision creates a chain reaction that ultimately affects the disposable income of individuals and businesses, thereby creating a ripple effect on the entire market.

Three Types of Fiscal Policy Forms and Their Mechanisms

Maintain Balance: Neutral Fiscal Policy

A neutral fiscal policy means that government revenue equals expenditure — this is the economic “cruise control” mode. Government spending matches tax revenue, with the goal of maintaining the status quo, neither stimulating nor suppressing the economy.

Imagine a family budgeting scenario: Alice and Bob have a combined monthly income of $2000, and they carefully plan their expenses to also be $2000. This is precisely the approach adopted by Germany in 2019 – maintaining economic stability through balanced government spending and avoiding new debt. This method is particularly popular during relatively stable economic periods as it provides predictability.

Stimulus Growth: Expansionary Fiscal Policy

When the economy enters a recession or unemployment rates are high, the government turns to expansionary measures—reducing taxes while increasing spending. This injects more money into the economy, increasing consumers' disposable income and encouraging businesses to expand hiring.

During the global financial crisis in 2008, the U.S. government implemented a large-scale stimulus plan. They reduced household tax burdens, giving consumers extra purchasing power. Alice used this money to renovate her house, and Bob bought a new computer. The demand for goods and services surged, leading businesses to hire more employees. With increased employment, more people had spending power, creating a virtuous cycle that helped the economy recover.

The power of this policy lies in its ability to quickly restart a stalled engine, but the cost is an increase in government debt.

Cooling Economy: Contractionary Fiscal Policy

When inflation gets out of control, the government takes the opposite strategy - increasing taxes and cutting spending, extracting funds from the economy to reduce overall demand.

Imagine that the government of the country where Alice and Bob live has raised taxes. Suddenly, the funds available for spending and investment have decreased. Alice has postponed her car purchase plan, and Bob has canceled his shopping list. Consumer demand has decreased, businesses are facing sales difficulties, which in turn slows down hiring. This cooling effect helps control rising prices, but may lead to an increase in unemployment in the short term.

In the early 1980s, the U.S. government implemented austerity measures to combat inflation. The increased taxation and reduced spending stabilized prices, but also led to a short-term rise in unemployment – a common trade-off of austerity policies.

The New Relationship Between Fiscal Policy and the Cryptocurrency Market

Although cryptocurrencies are said to be unaffected by traditional finance, changes in fiscal policy have a significant indirect impact on the prices of digital assets.

How expansionary policies boost cryptocurrency assets ###

Expansionary fiscal policy has released a large amount of cash into the economy. After consumers gain more disposable income, a portion will flow into investments — including cryptocurrencies. After Alice's taxes were reduced, she decided to use part of her savings to buy Bitcoin and Ethereum. When thousands of Alices do this, the demand for crypto assets rises, and prices subsequently increase.

During the COVID-19 pandemic, governments around the world launched large-scale stimulus plans and direct subsidies. Part of this funding flowed into the crypto market, becoming one of the driving forces behind the rise in digital asset prices at that time.

Pressure from tightening policies

On the contrary, when the government implements tight fiscal policy, the funds in the hands of consumers and investors decrease. Alice faces higher taxes, and she cancels her plans to purchase more Bitcoin. As investors reduce their buying, the demand in the crypto market decreases, and prices may stagnate or even drop.

The key point is that cryptocurrencies, as high-risk assets, are particularly sensitive to changes in disposable income—people only invest in them when they have extra money.

Economic Benefits of Fiscal Policy

Stability and Growth

A well-applied fiscal policy framework can create jobs during a recession and control prices during overheating. It not only balances the severe fluctuations of the economic cycle but also provides a foundation for long-term growth.

Infrastructure and Development

Increased public spending often flows into infrastructure. China's “Belt and Road” initiative represents an example of improving transportation, promoting trade, and driving regional economic development through expanded government spending.

Social Security and Equality

Through a progressive taxation system, the government can finance public services such as education and healthcare. Sweden's model demonstrates how to raise funds from high-income groups through higher taxation to provide free healthcare and higher education for all, reducing income inequality.

Summary

Fiscal policy is one of the most powerful economic tools in the hands of the government. By carefully adjusting taxation and spending, policymakers can guide unemployment rates down, control inflation, and promote growth. These changes also bypass the traditional financial system, having real and profound effects on emerging asset classes such as cryptocurrencies.

Understanding how fiscal policy works is crucial for any investor looking to predict market movements. Whether it's a global financial crisis or pandemic stimulus, the direction of fiscal policy is often the first signal—telling us where the economy is headed and where funds will flow.