ECON1020 Introductory Macroeconomics | Expansionary Fiscal Policy
Answer:
The government of a country imposes expansionary fiscal policy to increase aggregate demand through reducing tax and increasing government expenditure (Hsing and Morgan 2017). Through increasing public borrowing, the government can finance its expansionary fiscal policy.
Figure 1: Expansionary fiscal policy
Source: (created by author)
The above figure has represented expansionary fiscal policy where aggregate demand is shown by AD curve and aggregate supply is represented by AS curve. The AD curve shifts from AD to AD2 and consequently the real national output increases from Y1 to Y2 and aggregate price level increases from P1 to P2.
During a recession, the country experiences negative growth of gross domestic output for some consecutive quarters (Oboh 2017). To recover an economy from this recessionary period, the government takes expansionary fiscal policy.
To manage low growth of an economy within the business cycle, this type of policy plays significant role. However, excessive supply of money can cause high inflation. Moreover, this policy takes long time to work out after its implement. Moreover, this type of fiscal policy creates crowding-out effect, which increases interest rates and adversely affect private investment.
However, fiscal policy becomes effective compare to monetary policy when the economy falls in liquidity trade or deep recession.
References:
Hsing, Y. and Morgan, Y.C., 2017. Is real depreciation and expansionary fiscal policy effective? The case of Serbia. Economics, Management and Sustainability, 2(2), pp.24-30.
The case of Serbia. Economics, Management and Sustainability, 2(2), pp.24-30.
Oboh, V.U., 2017. Monetary and fiscal policy coordination in Nigeria: a set theoretic approach. Academic Journal of Economic Studies, 3(1), pp.48-58.
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