Malcolm Rivera
Fiscal expansion, also known as expansionary fiscal policy, is a set of economic measures taken by governments or central banks to stimulate economic growth. This is done by increasing aggregate demand through lower interest rates, increased government spending, or tax cuts. An example of fiscal expansion is the response to the 2008 financial crisis, where central banks around the world lowered interest rates to near-zero and conducted major stimulus spending programs.
| Characteristics | Values |
|---|---|
| Objective | To stimulate economic growth |
| Application | Used during periods of slow growth or recession |
| Mechanism | Increasing aggregate demand through lower interest rates, tax cuts, or increased government spending |
| Effect | Can increase inflation |
| Examples | The Economic Stimulus Act of 2008, American Recovery and Reinvestment Act, Quantitative Easing by the U.S. Federal Reserve |
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What You'll Learn
Tax cuts
During the 2008-2009 Great Recession, the US government's tax revenues declined from 18.5% of GDP in 2007 to 14.8% in 2009, while government spending rose. This combination of tax cuts and increased spending was an attempt to stimulate the economy and mitigate the effects of the recession. Similarly, in response to the COVID-19 pandemic, the US government provided Economic Impact Payments of up to $1,200 to taxpayers and additional Child Tax Credit opportunities, injecting money directly into the economy.
However, tax cuts as part of expansionary fiscal policy can have unintended consequences. One of the primary risks is inflation. While expansionary policies aim to reduce unemployment, they can also lead to higher prices, wages, and input costs. This occurs when the increase in the money supply outpaces the growth of the economy. Additionally, the effectiveness of tax cuts as a stimulus can vary. If tax cuts cause concerns about the sustainability of a country's fiscal position, the private sector may counteract government intervention by increasing savings or moving money offshore.
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Increased government spending
Expansionary fiscal policy can involve increased government spending on final goods and services, as well as grants to state and local governments, enabling them to increase their own expenditures. This type of policy can also take the form of government contracts, infusing the economy with more money and boosting demand. During expansionary periods, governments may increase spending on infrastructure projects, social programs, and other initiatives to stimulate economic growth. For example, in response to the 2008 financial crisis, the US government implemented the American Recovery and Reinvestment Act, injecting trillions of dollars into the economy to support aggregate demand and fortify the financial system.
A key objective of expansionary fiscal policy is to boost business investment and consumer spending by directly injecting money into the economy. This can be achieved through government deficit spending, such as stimulus checks, or increased lending to businesses and consumers. Additionally, expansionary fiscal policy can increase government transfers to those who are out of work, which can lead to higher private sector wages. However, it is important to note that higher public sector wages can also put pressure on private sector wages, reducing investment and economic growth.
The effectiveness of expansionary fiscal policy can be measured by its impact on the growth of output, known as the multiplier. Larger multipliers are generally associated with less leakage, accommodative monetary conditions, and a sustainable fiscal position. However, expansionary fiscal policy can have unintended consequences, such as inflation, particularly if the money supply increases faster than economic growth.
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Monetary and fiscal stimulus
Fiscal stimulus refers to raising government spending or reducing taxes. It is carried out by the government and is the last resort to achieve steady economic growth and price stability. It can include issuing stimulus cheques, creating tax breaks, or lowering the federal funds rate. It can also be used to redistribute revenue and capital. Fiscal stimulus can be used to increase demand for goods and services, which will help boost economic growth. However, it may also have the opposite effect, as people are more likely to save if uncertain about the future of the economy.
Monetary stimulus, on the other hand, is managed by the central bank of a country and is concerned with interest rates and the management of the money supply in an economy. It involves either expanding the supply of money or reducing the cost of money or the rate of interest to encourage consumer spending. Monetary stimulus can be used as a short- or long-term measure, while fiscal stimulus is typically used as a short-term measure.
Both monetary and fiscal stimulus packages are used when output and employment levels are much lower than what is sustainable, or when there is a recession.
Expansionary fiscal policy, which can be achieved through fiscal stimulus, occurs when the government cuts tax rates or increases government spending, shifting the aggregate demand curve to the right. It can be used to prevent or moderate economic downturns and recessions. It can also be used to fight unemployment. However, it may unintentionally cause higher prices and increase the rate of annual inflation.
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Increased disposable income
Disposable income is the amount of money an individual or household unit has left after paying taxes and other mandatory charges. It is the money that can be spent on necessities, such as food and rent, or used for discretionary purchases, leisure activities, and investments. Disposable income is a key indicator of the strength of the economy, and it is closely monitored by economists.
An increase in disposable income can lead to higher consumer spending and a boost in the economy. This is because, as disposable income rises, consumption tends to increase as well. This relationship is known as the Consumption Function and typically has a positive slope. For example, during economic booms, disposable income rises due to increased employment and higher wages, resulting in higher consumer spending. Conversely, in times of economic crisis, disposable income may decrease due to job losses and wage cuts, leading to reduced consumer spending and an economic slowdown.
Several factors can influence disposable income levels. Firstly, changes in taxation can directly impact disposable income. For instance, tax cuts or reductions in tax rates increase disposable income, while higher taxes or tax rate increases reduce it. Additionally, government benefits and social safety nets, such as unemployment insurance, can help maintain disposable income levels during economic downturns.
Fiscal policy plays a crucial role in shaping disposable income. It involves the use of government spending and taxation to influence the economy. Expansionary fiscal policy aims to boost the economy during slow growth or recession by increasing aggregate demand. This can be achieved through tax cuts, increases in government spending, or a combination of both. For example, issuing stimulus checks, creating tax breaks, and lowering interest rates are all expansionary fiscal policies that can lead to increased disposable income.
Increases in disposable income can have a positive impact on the economy. For instance, higher disposable income can lead to increased consumer spending, driving up demand for goods and services. This, in turn, can stimulate manufacturing levels, distribution, and overall economic well-being. Additionally, increased disposable income can contribute to higher savings rates, providing households with financial buffers and potentially increasing investment opportunities.
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Reduced unemployment
Fiscal expansion is a set of economic measures taken by a government or central bank to stimulate economic growth. It is also known as fiscal policy, which is the use of government spending and taxation to influence the economy. Governments typically use fiscal policy to promote strong and sustainable growth and reduce poverty.
Expansionary fiscal policy can be used to reduce unemployment. During a recession, the intersection of aggregate demand (AD0) and aggregate supply (AS0) occurs below the level of potential GDP. At the equilibrium (E0), unemployment rises. Expansionary fiscal policy can shift aggregate demand to AD1, closer to the full-employment level of output.
Expansionary fiscal policy can include issuing stimulus checks, creating tax breaks, or lowering the federal funds rate. It can also include increasing government purchases through increased federal government spending on final goods and services, and raising federal grants to state and local governments to increase their expenditures.
During expansionary periods, governments can increase spending on infrastructure projects, social programs, and other initiatives to boost demand and stimulate economic growth. They may also enact tax cuts to reduce taxes, which puts more money in consumers' pockets and stimulates spending.
However, it is important to note that expansionary policy can also lead to inflation. An increase in the money supply can lead to inflation if it outpaces the growth of the economy. This means that prices, wages, and input costs increase, even though people have more money.
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Frequently asked questions
Fiscal expansion, or expansionary fiscal policy, is a set of economic measures taken by a government or central bank to stimulate economic growth.
Examples of fiscal expansion include tax cuts and increased government spending. The Economic Stimulus Act of 2008, in which the US government sent taxpayers $600 or $1,200, is an example of a fiscal expansion in response to the 2008 financial crisis.
The goal of fiscal expansion is to boost the economy during periods of slow growth or recession. It is intended to increase aggregate demand and stimulate business investment and consumer spending.
Fiscal expansion can lead to significant costs and risks, including macroeconomic, microeconomic, and political economy issues. It can also unintentionally increase the rate of annual inflation.
