Question

Explain thoroughly when an expansionary fiscal policy is appropriate and when a contractionary fiscal policy is appropriate.   

Explain the three fiscal policies that can be used in expansionary fiscal policy.  Each policy must come with an example.  

Explain the three fiscal policies that can be used in contractionary fiscal policy.  Each policy must come with an example.  

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Answer 1

An expansionary fiscal policy is appropriate when the economy is travelling the downward trough of the business cycle i.e. facing an economic slowdown or a recession while a contractionary fiscal policy is appropriate at the time if boom when growth rates are high, consumer confidence is high and when investors are earning big.

Expansionary fiscal policy

1. Increase in government exoenditure, for example expenditure in roads and other infrastructure like India announced spending about ₹100000 crores on infrastructure in next 5 years

2. Decrease in tax rates, for example decrease in the direct taxes, corporate taxes, indirect taxes etc like India did a few months back

3. Increasing wages of the employees of public sector companies, India comes out with a public pay commision every couple of years to increase their purchasing power

4. Direct bank transfers, Indian government transfers ₹6000 per year in the bank accounts of selected farmers

Purpose of these policies is to increase aggregate demand which in turn would reduce unemployment snd have multiplied impact on GDP

Fiscal contration

the reverse of all the policies mentioned above as fiscal expansion. Main purpose is to cut the fiscal deficit in the time when their is an economic boom.

major policies used are

1. Increase in taxes, when oil prices are low Indian government generally increases taxes on crude to earn higher tax revenue

2. Cutting spending, like president Bill Clinton in his era cut spending in various sectors and president Roosevelt cut spending in 1933 to curb government’s expanding deficit

3. Indian government waved of subsidies on gas cylinders for 40% of the beneficiaries last year.