Question

If given a scenario, explain what type of discretionary fiscal policy (expansionary or contractionary) should be implemented and how the fiscal policy tools should be manipulated. Hint: Review recessionary and inflationary gaps.

Answer 1

Fiscal policy needs ,changes upon the macroeconomic environment prevailing. In case of Recessionary gaps when the real GDP is lower than potential GDP, Government interferes to push the economic activity through expansionary Fiscal policy which involves higher government spending, Lower taxation so as to incentivise people to raise their income ,increase disposable income that way increasing Consumption and economic activity and pushing GDP whereas at the same time in case of Inflationary gaps government interferes through contractionary policy to control inflation, reduce spendings and increase tax incidence