If the economy is sluggish, the government may use expansionary fiscal policy to stimulate growth. Typically, this approach involves cutting tax rates and/or increasing government spending. The point of expansionary fiscal policy is to grow the economy by increasing both consumer and business spending. If the government cuts the tax rate, consumers can buy more goods because they have more money; thus, consumer demand increases. And if businesses pay less taxes, the thinking goes, they can hire more employees because they have more money to spend on expansion.

When the government decides to spend more money as a fiscal policy, they may fund public-works projects, such as the building of dams and highways, which create jobs. The government might also increase expenditures on social welfare programs, such as social security or food stamps, increasing the amount of money that consumers have available to spend.

Not all fiscal policy is expansionary. Sometimes the economy grows too quickly, and the result is inflation—a general but steep increase in the prices of goods and services over time. For example, if workers' wages are rising at an average of three percent annually, and the costs of living (such as rent, health care, transportation, and food) are rising at a rate of ten percent, consumers will be unable to buy basic goods eventually.

One way to prevent or limit inflation is to use contractionary fiscal policy, a set of actions that tends to drive down prices. Taxes are increased, and public spending is cut. The result is that consumers have less money to spend, so they buy less, and this causes prices to fall. Contractionary fiscal policy is employed far less often than expansionary policy. As one might imagine, contractionary policy isn’t very popular since it reduces discretionary income, at least in the short term. However, over time, contractionary policy can preserve a nation's standard of living because it keeps prices in check.