Question

Suppose the economy is in a recession. Which of the following is a valid argument for using expansionary fiscal policy, instead of monetary policy?

Select one:

a. Fiscal policy is more effective than monetary policy in a deep recession

b. Fiscal policy is slower than monetary policy

c. Fiscal policymakers are subject to more political influence, so some of their spending tends to be wasteful.

d. Government spending could lead to lower growth through the crowding-out effect

Answer 1

A. Fiscal policy is more effective than monetary policy in a deep recession :  

Expansionary fiscal policy increases the level of aggregate demand, through either increases in government spending or reductions in tax rates. Expansionary policy can do this by (1) increasing consumption by raising disposable income through cuts in personal income taxes or payroll taxes; (2) increasing investment spending by raising after-tax profits through cuts in business taxes; and (3) increasing government purchases through increased federal government spending on final goods and services and raising federal grants to state and local governments to increase their expenditures on final goods and services. Contractionary fiscal policy does the reverse: it decreases the level of aggregate demand by decreasing consumption, decreasing investment, and decreasing government spending, either through cuts in government spending or increases in taxes. The aggregate demand/aggregate supply model is useful in judging whether expansionary or contractionary fiscal policy is appropriate.