Question

Assuming an economy is operating in a recession and the government wants to conduct an expansionary policy, but does not want to change interest rates or incur any more fiscal debt, discuss what policies are available to the government?

Answer 1

First we understand what is fiscal policy.

Fiscal policy refers to a policy use by the government either by change in tax rate or by government expenditure or sometimes do both.

As given in question we have not change the tax rate. So in this case government do expansionary fiscal policy by increasing government expenditure. As we know government expenditure is the component of GDP, because GDP = C + I + G + Net Export. Here, G is government expenditure. Increase in Govenment expenditure means increase in GDP, or in other words we can say that there is a direct relation between GDP and Government expenditure. So when GDP increases it indirectly affect the consumption and investment, so consumption and investment also increases. When consumption increases it means more production in the economy which causes more employment generation.

So finally we can say that by increasing government expenditure government can reduce the recession which prevails in the economy.