How does fiscal policy relate to the business cycle?

Fiscal policy plays a crucial role in managing the business cycle by using government spending and taxation to influence economic activity. During periods of economic downturns, known as recessions, government spending can serve as a powerful tool to stimulate demand. By increasing expenditures on public projects or providing tax cuts, the government injects money into the economy, which can lead to increased consumption and investment, thereby helping to counteract the negative effects of the recession. This stimulus can lead to increased employment, production, and overall economic growth.

Conversely, during expansions, fiscal policy can be used to cool down an overheating economy by reducing spending or increasing taxes to prevent inflation. Hence, using fiscal policy strategically helps to stabilize the economy throughout different phases of the business cycle.

The other choices do not accurately reflect the comprehensive role of fiscal policy in managing the economy during different phases. For instance, while fiscal policy might indirectly influence stock market performance, it is not its primary function. Interest rates are mainly influenced by monetary policy, not directly by fiscal policy, and claiming that fiscal policy has no significant effect during recessions overlooks its fundamental role in mitigating economic downturns.