Contractionary Fiscal Policy
Plain definition
Government policy that cuts spending, raises taxes, or both, to reduce aggregate demand and fight inflation.
In economics
Contractionary fiscal policy cools an overheating economy by draining demand: tax hikes reduce disposable income and consumption, spending cuts directly shrink government demand. It can reduce deficits, but it risks tipping the economy into recession and is politically painful to implement.
Example
With inflation running hot and the economy above potential GDP, the government lets a temporary tax cut expire and freezes federal hiring. Households spend less, government demand falls, and the combined drag eases upward pressure on prices.
Contractionary fiscal policy is confused with austerity as a moral judgment and with tight monetary policy. It is simply the demand-reducing side of fiscal policy (higher taxes, lower spending), distinct from the central bank raising interest rates, though both cool the economy.