Expansionary Fiscal Policy vs Contractionary Fiscal Policy
Expansionary Fiscal Policy and Contractionary Fiscal Policy are two Fiscal Policy concepts in AP Economics that students often mix up. In short: expansionary fiscal policy is expansionary fiscal policy is an increase in government spending or a cut in taxes used to boost aggregate demand in a recession. Meanwhile, contractionary fiscal policy is contractionary fiscal policy is a decrease in government spending or an increase in taxes used to reduce aggregate demand and fight inflation. Here is how they compare side by side.
Expansionary fiscal policy is an increase in government spending or a cut in taxes used to boost aggregate demand in a recession.
It shifts aggregate demand right, raising real GDP and lowering unemployment, often at the cost of higher prices and a larger budget deficit. It is most appropriate during a recessionary gap. Its impact can be weakened by crowding out and time lags.
Contractionary fiscal policy is a decrease in government spending or an increase in taxes used to reduce aggregate demand and fight inflation.
It shifts aggregate demand left, lowering the price level and real GDP and moving the budget toward surplus. It is used to close an inflationary gap. Political resistance often makes spending cuts and tax increases hard to enact.