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Fiscal policy can also be used to slow down an overheating economy. Economic studies of specific taxing and spending programs can help to inform decisions about whether taxes or spending should be changed, and in what ways. 95 In this well-functioning economy, each year aggregate supply and aggregate demand shift to the right so that the economy proceeds from equilibrium E0 to E1 to E2. The conflict over which policy tool to use can be frustrating to those who want to categorize economics as “liberal” or “conservative,” or who want to use economic models to argue against their political opponents. They are two different terms. The original equilibrium occurs at E0, the intersection of aggregate demand curve AD0 and aggregate supply curve AS0, at an output level of 200 and a price level of 90. A decrease in spending will decrease the aggregate demand curve as consumers will have less money to invest and consume. Expansionary fiscal policy, on the other hand, is often thought to lead to increases in interest rates. Figure 1 uses an aggregate demand/aggregate supply diagram to illustrate a healthy, growing economy. A discretionary fiscal policy is a type of active policy incorporating contractionary and expansionary measures to slow or speed up the growth of the economy. Generally speaking contractionary monetary policies and expansionary monetary policies involve changing the level of the money supply in a country. Consumers’ reaction to these policies may be positive or negative. Each year, the economy produces at potential GDP with only a small inflationary increase in the price level. The Great Recession meant less tax-generating economic activity, which triggered the automatic stabilizers that reduce taxes. Thus expansionary fiscal policy becomes ineffective in increasing the income level. Topic: Similarities and differences between the effect of expansionary and contractionary fiscal policy on aggregate demand. Monetary policy, by construction, lowers interest rates when it seeks to stimulate the economy and raises them when it seeks to cool the economy down. Again, the AD–AS model does not dictate how this contractionary fiscal policy is to be carried out. This can be represented as a shift to the left of the AD curve, reducing the equilibrium output of … Changes in Government spending 2. You can view the transcript for “Macro: Unit 3.1 — Types of Fiscal Policy” here (opens in new window). As these occur, the government may choose to use fiscal policy to address the difference. Fiscal policy is the use of government spending and tax policy to influence the path of the economy over time. A contractionary fiscal policy can shift aggregate demand down from AD0 to AD1, leading to a new equilibrium output E1, which occurs at potential GDP. However, state and local governments, whose budgets were also hard hit by the recession, began cutting their spending—a policy that offset federal expansionary policy. Choose the payment system that suits you most. increasing consumption by raising disposable income through cuts in personal income taxes or payroll taxes; increasing investments by raising after-tax profits through cuts in business taxes; and. Similarly when spending exceeds tax collection, there’s a budget deficit. Meaning increasing taxation or reducing government spending or both. This increase in spending will increase the aggregate demand curve as it allows customers to have more money at their disposal to consume and invest. The choice between whether to use tax or spending tools often has a political tinge. What is the difference between contractionary and expansionary fiscal policy? Explain the Keynesian logic for expansionary and contractionary fiscal policy for reducing unemployment and inflation; The GDP Gap. Expansionary and contractionary are two types of fiscal policy. When the economy is in recession, the expansionary fiscal policy is in order and the aggregate demand is a level lower than it would be in a full employment situation. Since the economy was originally producing below potential GDP, any inflationary increase in the price level from P0 to P1 that results should be relatively small. Both affect the demand and supply of goods and services in the economy which describes the economic graph. A Contractionary Fiscal Policy. Expansionary fiscal policy is implemented by reducing taxes and increasing government expenditure while contractionary fiscal policy works by increasing taxes and reducing government expenditure. Figure 3. Conversely, increases in aggregate demand could run ahead of increases in aggregate supply, causing inflationary increases in the price level. (using Microsoft Word, Times New Roman or Aerial, 12-point font, 1 inch margins, single or double space). Fiscal Policy in the United States. The Difference Between Expansionary and contractionary Monetary Policies: The business cycle is marked by growth and recessions. Monetary policy and fiscal policy refer to the two most widely recognized tools used to influence a nation's economic activity. Voters like both tax cuts and more benefits, and as a result, politicians that use … Using Fiscal Policy to Fight Recession, Unemployment, and Inflation. Question: 2. When the government observes unwanted inflationary trends, it can arrest or reduce such a trend by reducing its expenditure in relation to its tax revenue for the year. After the Great Recession of 2008–2009, U.S. government spending rose from 19.6% of GDP in 2007 to 24.6% in 2009, while tax revenues declined from 18.5% of GDP in 2007 to 14.8% in 2009. The economy starts at the equilibrium quantity of output Yr, which is above potential GDP. Contractionary fiscal policy happens when the government and its public agencies lowers its expenditures, while also decreasing spending or increasing taxes at the same time. What is the difference between contractionary and expansionary fiscal policy? (The figure uses the upward-sloping AS curve associated with a Keynesian economic approach, rather than the vertical AS curve associated with a neoclassical approach, because our focus is on macroeconomic policy over the short-run business cycle rather than over the long run.) On the other hand, discretionary fiscal policy is an active fiscal policy that uses expansionary or contractionary measures to speed the economy up or slow the economy down. As a general statement, conservatives and Republicans prefer to see expansionary fiscal policy carried out by tax cuts, while liberals and Democrats prefer that expansionary fiscal policy be implemented through spending increases. In 2011, Japan suffered from a natural disaster. Differences between expansionary and contractionary fiscal policy on aggregate demand: Expansionary fiscal policy: Similarities between the expansionary and contractionary fiscal policy: In both situations, implementation takes time due to legislative and administrative processes. At the equilibrium (E0), a recession occurs and unemployment rises. When the taxes collected are more than the spending, there’s a budget surplus. Contrary to this, the monetary policy maintains and regulates the money supply within the economy. The aggregate demand/aggregate supply model is useful in judging whether expansionary or contractionary fiscal policy is appropriate. A government can reduce aggregate demand (And for that matter inflation) in an economy by adopting contractionery fiscal policy. In this Buzzle article, you will come across the pros and cons of using expansionary and contractionary fiscal policy. This is the opposite of expansionary policy. Discretionary fiscal policy requires government action through Congress to make changes in spending or taxation; automatic stabilizers use spending in the form of transfer payments and taxation in the form of progressive income taxes to steady the economy automatically. This very large budget deficit was produced by a combination of automatic stabilizers and discretionary fiscal policy. This is referred to as an expansionary fiscal policy. The fiscal policy is the record of the revenue generated through taxes and its division for the different public expenditures. We’d love your input. This is accomplished by the government deliberately making changes " in either government spending or taxes to stimulate or slow down the economy" (Colander, 2004, p. 583). Some may prefer spending cuts; others may prefer tax increases; still others may say that it depends on the specific situation. Between monetary and fiscal policy, the former is generally viewed as having the largest impact on the economy, while fiscal policy is seen as being the less efficient way to influence growth trends. Any citation style (APA, MLA, Chicago/Turabian, Harvard). Consider first the situation in Figure 2, which is similar to the U.S. economy during the recession in 2008–2009. Explain The Difference Between Contractionary Fiscal Policy And Expansionary Fiscal Policy 3. The intersection of aggregate demand (AD0) and aggregate supply (AS0) occurs at equilibrium E0. The original equilibrium (E0) represents a recession, occurring at a quantity of output (Yr) below potential GDP. See the answer. One more year later, aggregate supply has again shifted to the right, now to AS2, and aggregate demand shifts right as well to AD2. 250 words. What Is the Difference Between Contractionary & Expansionary Monetary Policy? This could be caused by a number of possible reasons: households become hesitant about consuming; firms decide against investing as much; or perhaps the demand from other countries for exports diminishes. We deliver what we promise and we deliver it fast! Once your paper is ready, we will email it to you. In short, the figure shows an economy that is growing steadily year to year, producing at its potential GDP each year, with only small inflationary increases in the price level. Monetary Policy vs. Fiscal Policy: An Overview . Fiscal policy is the process the government uses to determine the appropriate level of taxes and spending necessary to deal with recessions, inflation, and unemployment. Most economists, even those who are concerned about a possible pattern of persistently large budget deficits, are much less concerned or even quite supportive of larger budget deficits in the short run of a few years during and immediately after a severe recession. 481 - 490 of 500 . The paper will be accustomed to your specification and to the format of your choice. One year later, aggregate supply has shifted to the right to AS1 in the process of long-term economic growth, and aggregate demand has also shifted to the right to AD1, keeping the economy operating at the new level of potential GDP. Consumers’ reaction to these policies may be positive or negative. Types of Expansionary Policy. The intersection of aggregate demand (AD0) and aggregate supply (AS0) is occurring below the level of potential GDP. Fiscal policy and monetary policy are similar in two aspects. We can write the body of the paper to any length (pages), in addition we can include the title page, abstract, Introductory text, Conclusion, and references pages. Whether the fiscal policy is expansionary or contractionary can be gauged by whether there is budget surplus or budget deficit. Expansionary fiscal policy occurs when the Congress acts to cut tax rates or increase government spending, shifting the aggregate demand curve to the right. Should the government use tax cuts or spending increases, or a mix of the two, to carry out expansionary fiscal policy? It consists of decreasing government purchases, increasing … In this situation, contractionary fiscal policy involving federal spending cuts or tax increases can help to reduce the upward pressure on the price level by shifting aggregate demand to the left, to AD1, and causing the new equilibrium E1 to be at potential GDP. Expansionary Fiscal Policy. Question: Compare And Contrast Expansionary And Contractionary Fiscal Policy. "What Is The Difference Between Contractionary And Expansionary Fiscal Policies Which Is More Appropriate Today Explain Your Answer How Might Contractionary And Expansionary Fiscal Policies Affect" Essays and Research Papers . Expansionary fiscal policy increases the level of aggregate demand, through either increases in government spending or reductions in taxes. Similarities between the expansionary and contractionary fiscal policy: When an economy is in a state where growth is getting out of control, contractionary fiscal policy comes into function. Business cycles of recession and boom are the consequence of shifts in aggregate supply and aggregate demand. A Healthy, Growing Economy. Alex Kocic - Updated March 23, 2017 Both contractionary and expansionary monetary policies are tools available to a country's central bank whose aim is to reduce or increase the money supply and … Both policies are interventions which regulate the direction of an economy. For example, investment by private firms in physical capital in the U.S. economy boomed during the late 1990s, rising from 14.1% of GDP in 1993 to 17.2% in 2000, before falling back to 15.2% by 2002. Expansionary fiscal policy helped Japan by raising thei… The insight and firsthand experience of our writers will make your dream come true. (The macroeconomy can be usefully split into aggregate supply, and aggregate demand.) The shifting of demand curve to the right will help the economy to grow. The difference between expansionary and contractionary fiscal policy is that one is meant to make the economy expand and the other is meant to make it slow down. In such a situation, the government limits its rate of spending. Give us a go! In order to remove this inflationary gap, the government may reduce its spending and increase the taxes. Contractionary Fiscal Policy: Fiscal policy can also be used to address inflationary problems created by an overheated business-cycle expansion. Follow these simple steps to get your paper done. Figure 1. The extremely high level of aggregate demand will generate inflationary increases in the price level. Contractionary fiscal policy is the opposite of expansionary fiscal policy. The GDP gap is defined as the difference between potential GDP and actual GDP, when both are measured in real terms. Which do you think is more appropriate today? This problem has been solved! Did you have an idea for improving this content? How might contractionary and expansionary fiscal policy affect the healthcare organization? 3. The government decreases government spending and increases taxes. Figure 2. In the real world, however, aggregate demand and aggregate supply do not always move neatly together, especially over short periods of time. Both affect the demand and supply of goods and services in the economy which describes the economic graph. Contractionary fiscal policy occurs when Congress raises tax rates or cuts government spending, shifting aggregate demand to the left. Automatic stabilizers, which we learned about in the last section, are a passive type of fiscal policy, since once the system is set up, Congress need not take any further action. Contractionary fiscal policy: In this case, expansionary fiscal policy using tax cuts or increases in government spending can shift aggregate demand to AD1, closer to the full-employment level of output. In both situations, implementation takes time due to legislative and administrative processes. Modification, adaptation, and original content. It is a powerful tool to regulate macroeconomic variables such as inflation and unemployment.. This causes consumption to fall as purchasing power declines. But the AD–AS model can be used both by advocates of smaller government, who seek to reduce taxes and government spending, and by advocates of bigger government, who seek to raise taxes and government spending. Contractionary fiscal policy occurs when Congress raises tax rates or cuts government spending, shifting aggregate demand to the left. Expansionary Monetary Policy under Floating Exchange Rate: Increase in NX will lead to an increase in AD (because NX is a component of AD) and this will in turn lead to an increase in the income level from Y 1 to Y 2. Expert Answer . Expansionary monetary policy is simply a policy which expands (increases) the supply of money, whereas contractionary monetary policy contracts (decreases) the supply of a country's currency. similarities between contractionary and expansionary fiscal policy Posted by October 5, 2020 Leave a comment on similarities between contractionary and expansionary fiscal policy | A decrease in spending will decrease the aggregate demand curve as consumers will have less money to invest and consume. Each phase of the business cycle comes with its … Conversely, the decision to reduce government spending is contractionary. Suppose the macro equilibrium occurs at a level of GDP above potential, as shown in Figure 3. Expansionary and contractionary fiscal policies raise and lower money supply, respectively, into the economy. In addition, the price level would rise back to the level P1 associated with potential GDP. Changes in tax collection The fiscal policy can be defined as discretionary (‘active’) Discretionary changes in government spending and taxes are at the option of the government, they do not occur automatically. On the other hand, the monetary policy is announced by the central bank. The north east area of the country was struck by a tsunami causing their country to endure financial issues. This kind of recession results in increased government spending or lower tax rates. Aggregate demand may fail to grow as fast as aggregate supply, or it may even decline causing a recession. Expansionary policy can do this by: Contractionary fiscal policy does the reverse: it decreases the level of aggregate demand by decreasing consumption, decreasing investments, and decreasing government spending, either through cuts in government spending or increases in taxes. My Nursing Term Papers. Both monetary and fiscal policy, in macroeconomics, are methods of managing aggregate demand. Differentiate between expansionary and contractionary fiscal policy Fiscal policy consists of: 1. Fill in the order form and provide all details of your assignment. First, they both represent a nation’s policies to regulate its economy. Another connection between fiscal policy and inflation can be seen in the effect that a contractionary fiscal policy has on the economy. The model only argues that, in this situation, aggregate demand needs to be reduced. You will get a personal manager and a discount. 1. Now, let us see how the monetary policy and fiscal policy impacts this unfavourable economic condition.Monetary PolicyIn case of recession, the expansionary monetary policy is applicable. Please Note: Do not get confused between fiscal policy and monetary policy. Explain What Is "Fiscal Lags" And How They Relate To Fiscal Policy Giving At Least Two (2) Examples With Explanations. A fiscal policy is a government intervention to control the economy. The governments fiscal actions are reflected in the fiscal budget. The Obama administration and Congress passed an $830 billion expansionary policy in early 2009 involving both tax cuts and increases in government spending, according to the Congressional Budget Office. But if aggregate demand does not smoothly shift to the right and match increases in aggregate supply, growth with deflation can develop. The new equilibrium (E1) is at an output level of 206 and a price level of 92. There are two main types of expansionary policy – fiscal policy and monetary policy Monetary Policy Monetary policy is an economic policy that manages the size and growth rate of the money supply in an economy. However, a shift of aggregate demand from AD0 to AD1, enacted through an expansionary fiscal policy, can move the economy to a new equilibrium output of E1 at the level of potential GDP. Differentiate Between Expansionary Fiscal Policy and Contractionary Fiscal Policy Maira Jzas. transcript for “Macro: Unit 3.1 — Types of Fiscal Policy” here (opens in new window), https://cnx.org/contents/vEmOHfirstname.lastname@example.org:T6rLOl1i@4/Using-Fiscal-Policy-to-Fight-R, https://www.youtube.com/watch?v=q-j8AUCLKgw, Explain how expansionary fiscal policy can increase aggregate demand and boost the economy, Explain how contractionary fiscal policy can decrease aggregate demand and depress the economy. 2. Let us suppose that there is a recession in a country. Contracrionery and expansionary fiscal policies are like two opposite poles. increasing government purchases through increased spending by the federal government on final goods and services and raising federal grants to state and local governments to increase their expenditures on final goods and services. Ultimately, decisions about whether to use tax or spending mechanisms to implement macroeconomic policy is, in part, a political decision rather than a purely economic one. How might contractionary and expansionary fiscal policy affect the healthcare organization? A contractionary fiscal policy is the opposite. Explain your answer. Compare and contrast expansionary and contractionary fiscal policy. Expansionary policy is used more often than its opposite, contractionary fiscal policy. The fiscal policy is administered and announced by the Ministry of Finance. Expansionary fiscal policy occurs when the Congress acts to cut tax rates or increase government spending, shifting the aggregate demand curve to the right. We believe that all students should have a chance to finish medical school. Watch the selected clip from this video to learn more about the ways that government can implement fiscal policies. Japan used expansionary fiscal policy to help get them out of that terrible economic situation. Now the equilibrium is E2, with an output level of 212 and a price level of 94. Expansionary policy involves raising government expenditures and lowering taxes so the government budget deficit can grow or the surplus to fall.
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