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The polarizing effects of choosing between expansionary and contractionary fiscal policy

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1. Introduction

Fiscal policy is a strategy used by governments to regulate economic activity in their country. The primary purpose of fiscal policy is to regulate the economy through governmentspending and taxation. The government can use fiscal policy to stimulate economic activity and create jobs, reduce inflation, and manage government debt (Kaur, 2023). This is a polarizing issue and a source of contention because whenever the country suffers an economic shock that causes a rise in the unemployment rate and a reduction in living standards, this issue becomes a topic of debate. Politicians, commentators, and members of the general public debate how to best encourage economic recovery.


2. Expansionary and Contractionary fiscal policy

Expansionary fiscal policy is an effective tool to stimulate economic activity during recession, but is more susceptible to political influence than monetary policy. Contractionary fiscal policies are actions taken by governments to reduce spending and raise taxes, resulting in slower economic growth. They can be used to limit inflation and reduce the national debt and budget deficit (Acar, 2000).


3. How can policymakers, constituency, and community come together to ensure that fiscal policy benefits all?

It is critical that fiscal policy benefits everyone. The primary approach to accomplish this is to ensure that fiscal policy also caters for the poor. Citizens are frequently confronted with socioeconomic issues such as poverty, inequality, and unemployment. Notwithstanding the large deployment of public resources to address them, an evaluation of whether the government is making the best use of fiscal policy to alleviate poverty and inequality is required. All parties affected and involved in decision-making need to work together to ensurethat fiscal policy decisions are fair and beneficial to all and that all parties achieve common ground. For instance, when the state administration decides to make adjustments to the tax base, they must do so in such a way that the change is pro-poor.


4. When is Contractionary Fiscal Policy Expansionary?

When an economy is in recession and produces less than its potential GDP, expansionary fiscal policy is most suitable. The contractionary fiscal policy reduces aggregate demand by either cutting government expenditure or raising taxes. Fiscal policy refers to changes in government spending and revenue behaviour designed to influence economic consequences. Expansionary fiscal policy is supposed to stimulate economic activity, whereas contractionary fiscal policy is expected to inhibit economic growth. Expansionary fiscal policy is often employed by policymakers to enhance GDP growth and the economic indicators that tend to move with GDP, such as employment and individual earnings. Expansionary fiscal policy also has a negative impact on interest rates, investment, currency rates, trade balance, and inflation, limiting the long-term effectiveness of consistent fiscal stimulus. If policymakers are concerned that the economy is overheating, which could lead to a recession, they can adopt contractionary fiscal policy to limit economic activity. The magnitude of fiscal policy's impact on GDP will also vary depending on where the economy is in the business cycle—whether in a recession or an expansion (Khanfir, 2017).


5. Expansionary versus Contractionary Fiscal Policy, which one is better?

Expansionary fiscal policy involves either raising or decreasing government spending or taxation. An economy that produces too much must be reduced. In that circumstance, contractionary fiscal policy i.e. cutting government expenditure or raising taxes, is the best option. Expansionary fiscal policy raises the amount of aggregate demand through increasing government spending or decreasing taxes. When an economy is in recession and produces less than its potential GDP, expansionary fiscal policy is most suitable (Gravelle and Hungerford, 2019).


6. Conclusion

The recent shocks of the Covid 19 epidemic demonstrated the importance of smart fiscal policy in enacting corrections and supporting the people while managing the economy during a tumultuous period. Yet, policymakers can make judgments without fully comprehending the demands of the people or the pulse of a situation, which can lead to unintended consequences. Policymakers must implement optimal checks and strike the proper balance between practical and populist actions in order to strike the right equilibrium.


References

Kaur, G. 2023. What is fiscal policy, and why does it matter?. Retrieved from : https://cointelegraph.com/news/what-is-fiscal-policy-and-why-does-it-matter

 

Gravelle, J. and Hungerford, T.L., 2019. Can contractionary fiscal policy be expansionary?. Congressional Research Service.

 

Khanfir, W., 2017. Can contractionary fiscal policy be expansionary? Evidence from Tunisia. Asian Journal of Economic Modelling5(2), pp.223-232.

 

Acar, M., 2000. Devaluation in developing countries: expansionary or contractionary?. Journal of Economic & Social Research2(1).

 

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