Tax cuts and increased spending are two of the most prominent examples of Fiscal Policy. Both policies aim to increase aggregate consumption and to draw down budget surpluses or reduce deficits. They are usually used to stimulate a recovery, or to reduce budget surpluses.
Classical macroeconomics considers Fiscal Policy an effective strategy that the government can use to counter the natural depression in economic activity and spending that occurs during a recession. Consumers and businesses reduce spending and invest when business conditions are poor. This causes the business environment to worsen and can make it difficult for businesses to recover.
How Economic Activity Changes during a Recession
Individuals’ purchasing habits change during recessions. They have to make new choices about what products they want to purchase. Their spending overall decreases. Businesses will see a decrease in their spending and economic activity, which results in lower revenue. This leads to higher unemployment and a greater decline in spending and economic activity.
John Maynard Keynes first identified this self-reinforcing cycle during the Great Depression. He did so in his book, “General Theory of Employment, Money, and Interest”. These tendencies of the business cycle were identified by Keynes as fiscal policy.
How tax cuts can stimulate economic activity
The government might try to offset the economic slowdown by offering a tax cut and an increase in government spending to help citizens. This could create jobs and reduce unemployment.
3 This is an example of tax cuts being expansionary fiscal policies.
Conservatives favor tax cuts for expansionary fiscal policy. They have less faith and faith in the government, but they believe more in markets.
Liberals are more confident that the government can spend wisely and more inclined to support government spending than tax cuts as a way to expand fiscal policy.
The American Recovery and Reinvestment Act 2009 is an example of expansionary fiscal policy. 5 This is an example of government spending as expansionary fiscal policy.
How can an expansionary fiscal policy help the economy?
The government can increase spending by creating jobs or lowering unemployment. Spending can be boosted by tax cuts that quickly put money in the hands of consumers. Overall, an expansionary fiscal policy could restore faith in the government. It can make people and businesses feel better about their finances and increase economic activity.
What are the negative aspects of fiscal expansion?
Inflation can be caused by all the spending that is sparked by fiscal expansion. Tax cuts that were made to support spending should be reversed. Furthermore, politicians may use fiscal expansion for political ends, and not for the benefit of the country.
What are the 3 types of fiscal policy?
There are three types of fiscal policies: expansionary, neutral, and contractionary. If the government does not feel the economy is stable and healthy, it will adopt a neutral policy. A fiscal policy that is expansionary involves spending more or cutting taxes in order to stop or end a recession. To slow down unsustainable economic growth, a contractionary fiscal policy would reduce spending or raise taxes.
