Fiscal policy is an economic policy which uses government spending and taxation to influence the economy. It is the sister of monetary policy conducted by central banks to affect a national money supply. The fiscal policy influences aggregate demand by changes in the level of taxation and government expenditure. We say that fiscal policy is loose or expansionary when spending is higher than revenue (i.e., the budget is in deficit). On the other hand, fiscal policy is said to be tight or contractionary when revenue is higher than spending (i.e., the government budget is in surplus).
Fiscal Policy and Gold
Although monetary factors often seem to be more important, fiscal policy may also be a significant driver of gold prices. When a fiscal deficit arises, it undermines the confidence in the economy and thus spurs safe-haven demand for gold. The best example may be the U.S. in the 2000s. President Bush created a twin deficit and significantly deteriorated the fiscal position of the country (as one can see in the chart below), which erased the investors’ faith in the greenback. When the U.S. dollar plunged, gold started its huge rally, confirming that it may be a hedge against irresponsible fiscal policies.
Chart 1: Federal surplus or deficit as percent of GDP from 1990 to 2015.
Moreover, fiscal deficits may be a source of high inflation if they are monetized. Indeed, practically all periods of hyperinflation in history occurred when government budget deficits were financed by money printing. It is an important issue for the precious metals market, as gold is, under certain conditions, an inflation hedge.
We encourage you to learn more about the shiny metal – not only about how fiscal policy affects it, but also how to successfully use gold as an investment and how to profitably trade it. A great way to start is to sign up for our gold newsletter today. It's free and if you don't like it, you can easily unsubscribe.