Question

Explain how fiscal policy can be implemented if an economy is in the down swing of a business cycle

Answer 1

A down swing of a business cycle refers to the phase when due to macroeconomic activities the economy starts to move towards a phase of recession , followed by a severe depression . The economy contracts in a down swing . The GDP falls , production , investment , employment etc everything shows a downward trend .

In such a situation expansionary fiscal policy is quite helpful . Expansionary fiscal policy encompasses the tools of decreasing taxes and increasing government spending in the economy . This causes supply of liquid money and as government spending is a part of aggregate demand , so AD rises . This causes price level to rise and also real GDP to rise , thus closing the recessionary gap . Also decline in taxes causes increase in disposable income , so consumer spending also rises , which again boosts AD .

This is how a fiscal policy is implemented during an economic down swing .