Question

Homework #8 1. Are increases in both government purchases and net taxes at the same time expansionary or contractionary? Would both changes together increase or decrease the federal government deficit?

Answer 1

In deciding fiscal policy, the government has two levers: it can change tax levels and/or it can change the rate of spending.
There are three types of fiscal policies: neutral, expansionary, and contractionary.
The state spends more money than it raises by taxes through expansionary fiscal policy. During recessions, this form of strategy is used to build a foundation for strong economic growth and to move the economy towards full employment.
The government collects more revenue by taxation than it spends through contractionary fiscal policy. During times of economic growth, this policy works well.

Consumption, expenditure, government spending, and net exports make up aggregate demand. As a result of changes in any of these elements, the aggregate demand curve will change.
Expansionary strategy includes an increase in government spending, tax cuts, or a mix of the two. This leads to a change in the aggregate demand curve in the right direction.
Contractionary strategy entails reduced government spending, higher taxes, or a mixture of both. This contributes to a change in the aggregate demand curve to the left.

Expansionary fiscal policy is used during a recession to kick-start the economy. This raises aggregate demand, which in turn increases the economy's production and employment. The state raises spending, lowers taxes, and allows a combination of the two in implementing expansionary strategy. As government spending is one of the components of aggregate demand, the demand curve will be shifted to the right by an increase in government spending. Reducing taxes will leave more disposable income and increase consumption and savings, and the aggregate demand curve will shift to the right