Question

The country of Cashewopia is in a recession, and the government is having a debate over whether to use typical fiscal policy, which focuses on stimulating the consumption side of the economy, or supply-side fiscal policy, which focuses on stimulating the production side of the economy. As the economic advisor to the president, you are asked to outline the pros and cons of each type of fiscal policy. Briefly outline these pros and cons.

Answer 1

Demand side fiscal expansion is likely to be more quick and more effective because it directly increases the disposable income. Reduction in taxes and increase in government spending have multiplier effect. However this is going to bring demand pull inflation because demand side fiscal expansion shifts the aggregate demand curve to the right raising the real GDP as well as the price level.

Supply side fiscal expansion is likely to be less effective and less certain. It works on the principle of incentives where tax incentives are given to both workers and industries in order to boost productivity. However it is not certain if such tax incentives really the work effort and productivity in the desired manner. an advantage is the fact that there will be a reduction in the rate of inflation because it will shift the aggregate supply curve to the right. This will increase the real GDP but reduce inflation.