Question

What is the effect of expansionary fiscal policy on unemployment and inflation? Go online and find an article that describes an example of expansionary fiscal policy and that illustrates one or both of these effects. Write a paragraph to summarize your findings. Your article needs to be a 'real-world' or 'current events' example from a reputable news site.

Answer 1

Effects of expansionary fiscal policy
Through increases in government spending and reduction in taxation, expansionary fiscal policy causes the aggregate demand to increase. As aggregate demand increases, production boosts up and this leads to decrease in unemployment. However, it may lead to an increase in Inflation.
Let us consider a real world situation: Recession 2008-09 (US)
Recession created a severe financial crisis not only in the United states, but it spread to the world. It brought low economic growth, high unemployment and weak macroeconomic future prospects. Economic growth on an average fell by 5.6% in US and UK especially. Unemployment rose by 5% and it was expected to rise by 7%.

The use of expansionary fiscal policy to correct recession
The following diagram shows a recession at Eo with equilibrium between ADo (aggregate demand) and SRASo (short run aggregate supply) occurring at Yo below potential GDP at price level Po.

With the help of expansionary fiscal policy especially increase in government spending or tax cuts, leads to increase in aggregate demand such that AD curve shifts from ADo to AD1 and intersects with LRAS (Long run Aggregate supply curve) and SRASo at E1. This leads to decrease in unemployment as output increases from Y0 to Y1.
However, at below potential GDP (Yo), the price level was Po. One of the effects of expansionary fiscal policy is that it leads to inflationary pressures as Price level increase from Po to P1.

However, many economist suggests that reduction in taxes had more positive effects in stimulating aggregate demand in response to recession of 2008-9.