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The impacts of expansionary fiscal policy
Expansionary fiscal policy involves government attempts to increase aggregate demand. It will
involve higher government spending and / or lower tax. In theory, higher government spending will
increase aggregate demand (AD=C+I+G+X-M) and lead to higher economic growth.
Expansionary Fiscal Policy
Lower taxes should increase disposable income of consumers leading to higher levels of consumer
spending. This should also increase aggregate demand and could lead to higher economic growth.
Expansionary Fiscal policy can also lead to inflation because of the higher demand in the economy.
Expansionary Fiscal Policy and Government Borrowing
Expansionary fiscal policy will lead to an increase in the size of a government's budget deficit. This is
a potential problem of expansionary fiscal policy. Higher borrowing could:
Cause markets to fear default and push up interest rates on government debt.
Evaluation of Expansionary Fiscal Policy
The impact of expansionary fiscal policy will depend on many factors:
What else is happening in the economy? E.g. US tried to cut taxes in 2008. In theory, this lower tax
should boost spending. However, the economy is experiencing falling house prices, lower confidence
and a shortage of credit because of all these factors expansionary fiscal policy is relatively ineffective.
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Does crowding out occur? Expansionary fiscal policy involves higher spending and more
government borrowing it could cause crowding. This means that although the government spend
more because they borrow from private sector, the private sector have less to spend and invest.
Therefore, overall AD doesn't increase.
Timing of Fiscal Policy
A key issue of expansionary fiscal policy is the state of the economy.…read more