Expansionary and Contractionary Fiscal Policies

Expansionary Fiscal Policy (AO3)

Expansionary fiscal policy refers to "the use of increased government spending and/or reduced taxes to stimulate economic activity and achieve macroeconomic objectives". It is used when trying to close recessionary gaps.

There are 2 ways fiscal policy can be expansionary:

• Cut taxes: This means people and businesses will take home more money, incentivizing more consumption/investment.

• Increase government spending (Main policy): Since G is a part of measuring real GDP (C + I + G + X - M), an increase in G will increase economic activity.

Contractionary Fiscal Policy (AO3)

The use of decreased government spending and/or increased taxes to reduce the level of economic activity and achieve macroeconomic objectives. This is used when the government wants to close inflationary gaps. 

There are 2 ways fiscal policy can be contractionary:

• Increase taxes: Firms and households will have less wealth, decreasing consumption and investment.

• Decrease government spending (Main policy)

Diagrams (AO4)

Expansionary

Contractionary