Answer to Question #76474 in Macroeconomics for Anitah

Question

With the use of a diagram,explain the effect of an expansionary fiscal policy on the equilibrium position of the economy and the adjustment process towards simultaneous equilibrium,assuming the economy is pursuing a flexible exchange rate system.

Answer 1

When an economy is in a recession, expansionary fiscal policy is in order. Typically this type of fiscal policy results in increased government spending and/or lower taxes. A recession results in a recessionary gap meaning that aggregate demand (ie, GDP) is at a level lower than it would be in a full employment situation. In order to close this gap, a government will typically increase their spending which will directly increase the aggregate demand curve (since government spending creates demand for goods and services). At the same time, the government may choose to cut taxes, which will indirectly affect the aggregate demand curve by allowing for consumers to have more money at their disposal to consume and invest. The actions of this expansionary fiscal policy would result in a shift of the aggregate demand curve to the right, which would result closing the recessionary gap and helping an economy grow.
Source:
https://economics.fundamentalfinance.com/fiscal-policy.php