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Do you think government prefer cutting spending or raising taxes when the economy is overheating?

Do you think government prefer cutting spending or raising taxes when the economy is overheating?

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Answer #1

The overheating of the economy refers to the situation when the actual aggregate demand exceeds the level of aggregate demand needed to achieve full employment. This situation leads to to an inflationary spiral.

To correct the situation of overheating the aggregate demand has to be reduced. The government uses fiscal policy for this purpose. There are two tools with to manage aggregate demand. The government can either use government spending or Taxes or both for this purpose. To reduce aggregate demand my government would have to either reduce government spending or has to increase taxes. This will reduce the aggregate demand and the overheating of the economy stops.

Therefore the government prefers cutting spending for raising taxes when the economy is overheating.

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