This can be represented as a shift to the left of the AD curve, reducing the equilibrium output of the economy and hence, reducing GDP. The government will apply each policy depending on the country's needs. What is the difference between a contractionary and expansionary fiscal policy? Answered by Leonor F. Need help with Economics? One to one online tuition can be a great way to brush up on your Economics knowledge. Answered by Karishma B. Should the government use tax cuts or spending increases, or a mix of the two, to carry out expansionary fiscal policy?
After the Great Recession of —, U. This very large budget deficit was produced by a combination of automatic stabilizers and discretionary fiscal policy. The Great Recession meant less tax-generating economic activity, which triggered the automatic stabilizers that reduce taxes.
Most economists, even those who are concerned about a possible pattern of persistently large budget deficits, are much less concerned or even quite supportive of larger budget deficits in the short run of a few years during and immediately after a severe recession. The choice between whether to use tax or spending tools often has a political tinge.
As a general statement, conservatives and Republicans prefer to see expansionary fiscal policy carried out by tax cuts, while liberals and Democrats prefer that expansionary fiscal policy be implemented through spending increases. However, state and local governments, whose budgets were also hard hit by the recession, began cutting their spending—a policy that offset federal expansionary policy.
But the AD—AS model can be used both by advocates of smaller government, who seek to reduce taxes and government spending, and by advocates of bigger government, who seek to raise taxes and government spending. Economic studies of specific taxing and spending programs can help to inform decisions about whether taxes or spending should be changed, and in what ways. Ultimately, decisions about whether to use tax or spending mechanisms to implement macroeconomic policy is, in part, a political decision rather than a purely economic one.
Watch the selected clip from this video to learn more about the ways that government can implement fiscal policies. Fiscal policy can also be used to slow down an overheating economy.
Suppose the macro equilibrium occurs at a level of GDP above potential, as shown in Figure 3. In this situation, contractionary fiscal policy involving federal spending cuts or tax increases can help to reduce the upward pressure on the price level by shifting aggregate demand to the left, to AD 1 , and causing the new equilibrium E 1 to be at potential GDP.
Figure 3. A Contractionary Fiscal Policy. The economy starts at the equilibrium quantity of output Yr, which is above potential GDP. The extremely high level of aggregate demand will generate inflationary increases in the price level. A contractionary fiscal policy can shift aggregate demand down from AD 0 to AD 1 , leading to a new equilibrium output E 1 , which occurs at potential GDP. Improve this page Learn More. Skip to main content. Module Fiscal Policy. Search for:. An expansionary monetary policy is implemented by lowering key interest rates thus increasing market liquidity money supply.
High market liquidity usually encourages more economic activity. A contractionary monetary policy is focused on contracting decreasing the money supply in an economy. A contractionary monetary policy is implemented by increasing key interest rates thus reducing market liquidity money supply.
Low market liquidity usually negatively affect production and consumption. This may also have a negative effect on economic growth. When RBI adopt a contractionary monetary policy, the central bank.
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