Question

Suppose the country is currently experiencing a recession. What type of fiscal policy can the government use to fight off recession?

Answer 1

Expansionary fiscal policy raises the amount of aggregate demand, either through government spending raises or tax rate cuts. Expansionary policies will achieve so by (1) increasing demand by raising disposable income by reducing personal income taxes or payroll taxes; (2) increasing consumer expenditures by raising after-tax profits by lowering corporate taxes; and (3) increasing government purchases by increasing federal government spending on final goods and services, and raising federal grants to state and local authorities.

Instead of lowering taxes, the government can pursue economic expansion through spending increases (without the corresponding tax increases). It could increase jobs, for example, by building more highways, driving up demand and growth.

Expansionary fiscal policy is usually characterized by deficit spending, when government spending exceeds tax revenues and other sources. By fact, spending on the deficit appears to benefit from a combination of tax cuts and increased spending.