When an economy slows, two main forces can try to lift it. One is the central bank, which can cut interest rates. The other is the government, which can spend more or tax less. That second approach is called fiscal stimulus, and it has a big influence on bond markets, currencies and shares.
What fiscal stimulus is
Fiscal policy is how a government uses spending and taxation to influence the economy. Fiscal stimulus means increasing spending, cutting taxes, or both, to boost demand. Examples include infrastructure projects, support payments to households, subsidies for businesses and temporary tax breaks.
How it differs from monetary policy
Monetary policy is set by the central bank, such as the Bank of England or the US Federal Reserve. It works mainly through interest rates and the supply of money. Fiscal policy is set by the government and approved by parliament or congress. Monetary policy can be changed quickly at regular meetings; fiscal policy usually takes longer because it needs political agreement. The two can work together or pull in different directions.
How stimulus is paid for
If a government spends more than it collects in taxes, it borrows the difference by selling bonds. In the UK these are gilts; in the US they are Treasuries. That is why fiscal stimulus often affects bond markets. More borrowing means more bonds for investors to buy, and if investors are worried about the amount, they may demand higher yields.
Market effects
In the short term, stimulus can lift growth and company profits, which tends to support shares, particularly in sectors that benefit directly, such as construction or consumer spending. But if the economy is already running hot, stimulus can add to inflation, which may push the central bank to keep interest rates higher for longer. Higher rates can then weigh on shares and support the currency.
Investors watch how stimulus is funded and how credible a government’s plans are. UK markets learned this sharply in 2022, when unfunded tax cuts led to a rapid jump in gilt yields. Our guide to fiscal rules explains why governments set limits on borrowing.
Why it matters now
With elections and budgets often bringing promises of new spending or tax changes, traders pay close attention to what governments can actually deliver and how they will pay for it. Our latest Morning Market Brief touches on how bond yields are reacting to the current mix of politics, inflation and oil.
The beginner takeaway
Fiscal stimulus can boost growth, but it is not free. Watch who pays, how much is borrowed and how the central bank responds, because those decide whether stimulus helps or hurts markets.
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