Some may prefer spending cuts; others may prefer tax increases; still others may say that it depends on the specific situation. The model only argues that, in this situation, the government needs to reduce aggregate demand.
Expansionary fiscal policy increases the level of aggregate demand, either through increases in government spending or through reductions in taxes. Expansionary fiscal policy is most appropriate when an economy is in recession and producing below its potential GDP. Contractionary fiscal policy decreases the level of aggregate demand, either through cuts in government spending or increases in taxes.
Contractionary fiscal policy is most appropriate when an economy is producing above its potential GDP. What is the main reason for employing contractionary fiscal policy in a time of strong economic growth? What is the main reason for employing expansionary fiscal policy during a recession?
What is the difference between expansionary fiscal policy and contractionary fiscal policy? Under what general macroeconomic circumstances might a government use expansionary fiscal policy? When might it use contractionary fiscal policy? Is expansionary fiscal policy more attractive to politicians who believe in larger government or to politicians who believe in smaller government?
Explain your answer. Specify whether expansionary or contractionary fiscal policy would seem to be most appropriate in response to each of the situations below and sketch a diagram using aggregate demand and aggregate supply curves to illustrate your answer:. Alesina, Alberto, and Francesco Giavazzi. Chicago: University Of Chicago Press, Martin, Fernando M. Louis: Economic Synopses. Last modified February 14, Lucking, Brian, and Dan Wilson.
Fiscal Policy: Headwind or Tailwind? Greenstone, Michael, and Adam Looney. Skip to content Government Budgets and Fiscal Policy. Learning Objectives By the end of this section, you will be able to: Explain how expansionary fiscal policy can shift aggregate demand and influence the economy Explain how contractionary fiscal policy can shift aggregate demand and influence the economy.
View shopping cart. View mytutor2u. Account Shopping cart Logout. Explore Economics Economics Search. Explore Blog Reference library Collections Shop. Share: Facebook Twitter Email Print page. A reflationary fiscal stance happens when the government is running a budget deficit. A deflationary fiscal stance happens when the government runs a budget surplus i. Here is the justification: There is an automatic rise in the budget deficit to cushion the fall in AD caused by a shock such as the credit crunch.
A higher deficit is needed to lift AD back towards pre-recession levels If this works the budget deficit will improve as a result of higher tax revenues and reductions in welfare spending. Tightening the money supply discourages business expansion and consumer spending and negatively impacts exporters, which can reduce aggregate demand. Fiscal Policy. Your Privacy Rights. To change or withdraw your consent choices for Investopedia.
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I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. Economy Fiscal Policy. Key Takeaways Aggregate demand is an economic measure of the total demand for all finished goods or services created in an economy.
It represents the overall demand regardless of the price level, during a specific period of time. Aggregate demand and gross domestic product GDP are calculated the same way and move in tandem, increasing or decreasing simultaneously.
In the same way that fiscal and monetary policy impact GDP, they also impact aggregate demand. Monetary Policy and the Money Supply. Which Policy Is More Effective? The Bottom Line. Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts.
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Related Articles. Federal Reserve Fiscal Policy vs. Monetary Policy: Pros and Cons. Federal Reserve What happens if the Federal Reserve lowers the reserve ratio?
Macroeconomics Stagflation in the s. Fiscal Policy: What's the Difference? Partner Links. Monetary policy is a set of actions available to a nation's central bank to achieve sustainable economic growth by adjusting the money supply. Pushing On A String Definition Pushing on a string is a metaphor for the limits of monetary policy when households and businesses hoard cash in the face of a recession.
What Is Fiscal Policy? Fiscal policy uses government spending and tax policies to influence macroeconomic conditions, including aggregate demand, employment, and inflation. What Is Response Lag? Response lag is the time it takes for monetary and fiscal policies to affect the economy once they have been implemented.
Easy Money Definition Easy money is when the Fed allows cash to build up within the banking system in order to lower interest rates and boost lending activity. What Is the Key Rate?
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