Question

What are the four advantages and disadvantages of contractionary fiscal policy?

Answer 1

As its name suggests a "Contractionary fiscal policy" is a policy of the government which contracts the economy. Contraction is in the sense that it decreases the overall supply of money in the market. The government decreases the money supply either by reducing the government expenditure or by increasing the tax rate or both. This decreases the money available with the public and hence lowers the level of economic activities.

Advantages of a contractionary fiscal policy are -

• Reducing government expenditure increases money with the government. So government can use this money to pay back the previous debts(loans).
• This brings the price level to a moderate or low level which helps the consumers.
• Increase in the tax increases the government revenue and hence the budget deficit of the government is reduced.
• Sometimes it is very important to control the spread of hyper inflation.

Disadvantages of contractionary fiscal policy are -

• It may create large unemployment due to slow down of production process.
• Decrease in government spending may affect many welfare programmes of the economy which is very important for poor people.
• Slowing production may effect firms and industries and discourage them to invest and some firms may shut down. But it is very difficult to recover in the future.
• Increasing taxes discourage people to work hard or they may feel bad about the government.
• It may reduce the overall economic growth of the economy.