Question

Describe fully Fiscal policy. If the economy is slowing down and heading towards recession what fiscal policy tools (note tools is plural) would I use to reverse the economic slowdown?

Answer 1

If the economy is approaching recession expansionary fiscal policy is recemmonded.

Tools of expansionary fiscal policy are the following-

i) increase in governement spending- this leads to increase aggregate demand and results in higher real gdp in the economy.

ii) decrease in tax rate- decrease in tax rate increases disposable income. Consumption depends positively on disposable income. Thus consumption spending increases which leads to increase in aggregate demand.

iii) increase in transfers- increase in transfers increases disposable income which leads to increase in consumption spending and aggregate demand.