Question

Using words and graphs analyze the macroeconomic effects of expansionary fiscal policy in the short run. Provide as much detail as possible.

Answer 1

In IS-LM model, expansionary fiscal policy increases output, which shifts IS curve to right, increasing interest rate and increasing output. In following graph, IS0 and LM0 are initial IS and LM curves intersecting at point A with initial interest rate r0 and output Y0. As expansionary fiscal policy is implemented, IS0 shifts right to IS1, intersecting LM0 at point B with higher interest rate r1 and higher output Y1.

In AD-AS model, expansionary fiscal policy increases government spending or decreases taxes, both of which increase aggregate demand and shifts AD curve to right, increasing both price level and real GDP. In following graph, AD0 and SRAS0 are initial aggregate demand and short run aggregate supply curves intersecting at point A with initial price level P0 and real GDP Y0. As expansionary fiscal policy takes place, AD0 shifts right to AD1, intersecting SRAS0 at point B with higher price level P1 and higher real GDP Y1.