What is Expansionary Fiscal Policy?

  • Riya Kumari
  • Jan 27, 2021
  • Financial Analytics
What is Expansionary Fiscal Policy? title banner

Do you know what Fiscal Policy is? Before learning the Expansionary Fiscal Policy, you need to gain some knowledge of fiscal policy.

 

Fiscal policy is a way by which the government attempts to control the economy. It is mainly based on notions from John Maynard Keynes, who opposed governments could solidify the business cycle and oversee financial outcomes.

 

In simple words, we can say that fiscal policy alludes to the use of government spending and tax policies to make an impact on financial situations. Expansionary fiscal policy is a form of fiscal policy that involves decreasing taxes, increasing government expenditures, or both, to fight recessionary pressures.

 

An expansionary fiscal policy looks to incite financial movement by putting more cash into the hand of consumers and organizations. It is one of the significant ways governments react to withdrawals in the business cycle and deter a financial downturn.


 

What is Expansionary Policy?

 

The expansionary or loose policy is a type of macroeconomic policy that looks to empower monetary development. It is essential for the overall policy prescription of Keynesian financial aspects, to be used during the economic slowdown and recession to direct the drawback of financial cycles. 

 

Even though it is well known, the expansionary policy can include huge expenses and risks including macroeconomic, microeconomic, and political economy cases. The fundamental goal of the expansionary policy is to support total interest to compensate for setbacks in private demand.

 

There are two types of expansionary policy- Monetary policy and Fiscal policy. The expansionary monetary policy directs on raised money supply, whereas expansionary fiscal policy focuses on increased investment by the government into the economy.

 

Here in this blog, we will cover expansionary fiscal policy in detail.


 

 

Explaining Expansionary Fiscal Policy

 

Expansionary fiscal policy is applied at the point of time at which the government enhances the money supply in the economy. They do so by using budgetary tools to either increase spending or cut taxes, the two of which give customers and organizations more money to spend.

 

In most of the developed countries like the United States, fiscal policy is agreed upon by the administrative and/or legislative departments. In the U.S., through the federal budget, Congress sets fiscal policy and budgets bills in which the president must then sign into law.

 

(Also read: Capital in Economics)

 

An expansionary fiscal policy looks to expand aggregate demand through a blend of expanded government spending and tax reductions. 

 

The thought is that by placing more money under the control of buyers, the government can encourage monetary action during seasons of financial compression.

 

While expansionary policy essentially increments the spending deficiency or decline overflows temporarily, the thought is that by invigorating more financial action, the general economy will extend, compensating for momentary shortfalls with long haul monetary development.

 

This is because even a moderately limited stimulus if insightfully focused on, can have a multiplier impact across the whole economy.

 

The flipside of the expansionary fiscal policy is a contractionary fiscal policy, which includes increasing taxes or diminishing government spending, shifting aggregate demand to the left.


 

Purpose of Expansionary Fiscal Policy

 

Expansionary Fiscal Policy (also Expansionary Monetary Policy) is one of the most effective tools used by the governments to promote monetary activities during the time of recession.

 

Simply, we can say that the major purpose of expansionary fiscal policy is to increase growth to a strong financial phase, which is required during the contractionary stage of the business cycle.

 

The main motive of the government is to lower unemployment, raise consumer demand, and also avoid a recession. During recession periods, aggregate demand drops as organizations and buyers cut back on their spending. 

 

Whenever left unchecked, a drop in aggregate demand can make an endless loop, whereby feeble purchaser demand drives organizations to contribute less, which further pushes down interest, etc.

 

To counter this cycle, an expansionary fiscal policy has two fundamental tools:

 

  1. Tax cuts, whether they take the form of overall rate decreases or refundable credits put more money straightforwardly into the pockets of customers.

  2. Expanded government spending, through, regularly on open works, to boost the overall level of employment.

 

In these two points, you may have noticed that the most crucial objective of the expansionary fiscal policy is to expand demand in the economy by giving individuals more discretionary cash flow, both to incite customer spending and business investment. 

 

Thus, this is not the same as an expansionary monetary policy, which depends on giving securities and bringing interest rates all together down to prod loaning concerning banks and enhancing the money supply.


 

How does it work?

 

If the government cuts income tax, at that point this will enhance the disposable cash flow of purchasers and empower them to expand spending.

 

Higher utilization will raise total interest and this should prompt higher financial development.

 

This infusion of money into the economy can likewise cause a positive multiplier impact.

 

For instance, manufacturers who acquire a work will likewise spend additionally making occupations somewhere else in the economy. From the public authority's underlying infusion the last expansion in genuine GDP will be more than the underlying investment. 

 

(Check also: What is the Federal Reserve System?

 

Corporate tax cuts put more money into organizations' hands, which the government expectations will be put toward new investments and expanding business.

 

In that manner, tax cuts make employment, yet if the organization already has enough money, it might utilize the cut to repurchase stocks or buy new organizations.

 

The hypothesis of supply-side financial aspects suggests bringing down corporate expenses rather than income taxes, and promoters for lower capital additions charges to expand the business venture.

 

The expansionary fiscal policy can likewise lead to inflation due to more demand in the economy.


 

Benefits and Drawbacks of Expansionary Fiscal Policy

 

We all know that everything comes with pros and cons, so does this. Thus, let’s catch a glimpse at some benefits and drawbacks of expansionary fiscal policy.

 

Benefits

 

  • The main benefit of expansionary fiscal policy is that it works very fast if done accurately.

  • It expands profitability since it targets expanding the money supply. Also, there is a high demand for goods and services, and organizations gear ready for rising production in terms of quality and quantity.

  • It helps fuel the financial development of the nation, particularly during a downturn. Subsequently, it is commonly embraced during low-development stages. It diminishes decreases in loan applications and interest rates and prompts an expanded overflowing of capital into the economy.

  • There is one more important thing about expansionary fiscal policy, it restores customers' and organizations' confidence.

  • Because of the expansion in income and profit, there is an increasing demand for labour. Before borrowing is made easier, so organizations think that it is profitable to boost operations and hire new workers. Consequently, it helps in reducing unemployment.

 

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Drawbacks

 

  • It expands the expenditure of the government, so it leads to reduced taxation. A reduction in taxes would lead to an increment in the deficit of the government financial plan and this would run towards high borrowing and rising government debt.

  • There is a lack of value stability on different items. The expansion in the money supply makes it lose its significance concerning the related items, and greater expense is set for restricted products.

  • Politicians always use expansionary fiscal policy for other reasons which may not be related to the main purpose.

  • If the government isn't very cautious concerning its expenditure and if there is an overabundance of money supply, this policy could lead to inflation. Expanded inflation leads to pointless issues in the economy.

 

 

Key Takeaways

 

  • Fiscal policy means the use of government spending and tax policies to make an effect on monetary matters.

  • The expansionary policy includes a rise in government spending, a reduction in taxes, or even a mixture of the two.

  • The main motive of the expansionary policy is to support total interest to compensate for setbacks in private demand.

  • The purpose of expansionary fiscal policy is to enhance development to a strong financial stage, which is required during the contractionary stage of the business cycle.

  • There are several advantages of expansionary fiscal policy like, if done correctly it works very fast, expands profitability, during the recession it works as a fuel to the financial development, and many more.

  • Also, there are some disadvantages of expansionary fiscal policy such as it reduced taxation, politicians use it for their own benefits, leads to inflation, and many more. 

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