Question

Under what general macroeconomic circumstances might a government use expansionary fiscal policy? When might it use contractionary fiscal policy?

Short answer

A government might use expansionary fiscal policy in situations like high unemployment, low GDP growth, and economic recession to stimulate economic growth and reduce unemployment. On the other hand, contractionary fiscal policy may be employed during times of high inflation, an overheating economy, or high public debt to slow down economic growth, stabilize prices, and restore fiscal sustainability.

Step-by-step solution

Definition of Expansionary Fiscal Policy

Expansionary fiscal policy is a strategy used by the government to increase economic growth and reduce unemployment by increasing government spending, decreasing taxes, or both. This approach is typically used in times of economic recession or slowdown when aggregate demand in the economy is low.

Definition of Contractionary Fiscal Policy

Contractionary fiscal policy refers to measures taken by the government to reduce inflation by decreasing government spending, increasing taxes, or both. This policy is employed when an economy is growing too quickly, and there is a risk of high inflation as a result.

Circumstances for Expansionary Fiscal Policy

A government might use expansionary fiscal policy under the following general macroeconomic circumstances: 1. High unemployment rate: In times of high unemployment, the government may decide to use expansionary fiscal policy to stimulate job creation and reduce the unemployment rate. 2. Low GDP growth: If the economy is experiencing low GDP growth, the government may use this policy to increase demand and boost economic activity. 3. Economic recession: During an economic recession, the government may use expansionary fiscal policy to help the economy recover more quickly by increasing aggregate demand.

Circumstances for Contractionary Fiscal Policy

A government might use contractionary fiscal policy under the following general macroeconomic circumstances: 1. High inflation rate: Contractionary fiscal policy may be used to combat high inflation rates by slowing down economic growth, which could help stabilize prices. 2. Overheating economy: If an economy is overheating, meaning it is growing too quickly and at an unsustainable rate, the government may implement contractionary fiscal policy measures to cool down the economy and prevent potential financial instability. 3. High public debt: In situations where a country has high public debt, the government may use contractionary fiscal policy to reduce the fiscal deficit and restore fiscal sustainability. In conclusion, a government may use expansionary fiscal policy under circumstances such as high unemployment, low GDP growth, and economic recession, while it might use contractionary fiscal policy during times of high inflation, an overheating economy, or high public debt.