Expansionary fiscal policy aims to boost aggregate demand, leading to higher economic growth, reduced unemployment, and potential demand-pull inflation
In reality, controlling inflation is not the government's job, but expansionary fiscal policy can be used to redistribute income and reduce income inequality
Fiscal policy
A macroeconomic policy that involves changes to government spending and taxation to influence aggregate demand in the economy
Contractionary fiscal policy
Changes to governmentspending and taxation that aim to reduce aggregate demand
Expansionary fiscal policy
Changes to government spending and taxation that aim to boost aggregate demand
In theory, expansionary fiscal policy can help increase economic growth, reduce unemployment, and increase demand-pull inflation
The multiplier effect is a concept where an increase in aggregate demand leads to higher incomes, more spending, and a cycle of increased spending and income, resulting in even higher economic growth
Contractionary fiscal policy aims to reduce aggregate demand to cool down an overheating economy, reduce inflation, reduce budget deficit, control government finances, and redistribute income
Reduction in regressive taxation
Increases disposable income for the poor more than the rich, boosting consumption and AD
Reduction in income tax incentivizes workers to be more productive
Increases productivity of labor, boosting LRAS
Expansionary fiscal policy can boost long-run aggregate supply (LRAS)
Side effect of certain policies boosting the productive potential of the economy
More spending leads to more ad and more incomes
Creates a virtuous cycle of spending and income, resulting in an even higher increase in AD and economic growth
Government spending on education, health, and infrastructure boosts productivity of labor and capital
Increases LRAS and potentially boosts quantity of capital
Primary focus of expansionary fiscal policy is to boost aggregate demand
Reduction in corporation tax boosts investment
Boosts LRAS via increase in quantity and quality of capital and improvement in productive efficiency
Government spending on healthcare, education, infrastructure, and public sector wages
Boosts G in the aggregate demand equation and AD
Cutting income tax increases disposable income
Increases marginal propensity to consume, boosting consumption in the aggregate demand equation and AD
Reduction in income tax incentivizes inactive population to become active
Increases quantity of labor and boosts LRAS
Multiplier linked to expansionary fiscal policies
Focus on tax policies, such as cutting income tax for higher income brackets, reducing income tax rates for lower income brackets, widening tax-free allowance, or tax bands
Reduction in corporation tax
Increases retained profit for businesses, leading to increased investment and boosting AD