What is expansionary fiscal policy?

Fiscal policy means changing the government expenditure and taxation level to influence national output.

With an expansionary fiscal policy, the government tends to increase government expenditures and cut taxes. Expansionary fiscal policy can be used when an economy is in a recession position.

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What is the fiscal policy?

Fiscal policy is a demand-side economic policy that makes the changes to the aggregate demand of a nation. To see how supply side economic policies work, kindly click here

Fiscal policy means changing the government expenditure level and taxation level with the intention to influence the output level of the economy. There is a another major demand side economic policy that is called as “monetary policy”. To see, objectives and tools of the monetary policy, kindly click here

Objectives of the fiscal policy

Fiscal policy aims at,

  • Price stability
  • Full employment
  • Healthy growth rates.

Tools of the fiscal policy

So, there are two major tools of the fiscal policy. They are

1.Government expenditure

2. Tax implementation

Types of the fiscal policy

There are three major types of fiscal policy. They are,

  • Expansionary fiscal policy
  • Neutral fiscal policy
  • Contractionary fiscal policy.

Expansionary fiscal policy

 With an expansionary fiscal policy, the government tends to increase government expenditures and cut taxes. Expansionary fiscal policy can be used when an economy is in a recession position.

Neutral fiscal policy

Neutral fiscal policy means avoiding doing any change to the government expenditure and the tax policies. When an economy is in without recession or inflation, we can use neutral fiscal policy.

Contractionary fiscal policy

In the contractionary fiscal policy, the government decreases its expenditure and increases taxes. When an economy is in an inflationary situation, we can use contractionary fiscal policy

Policy for Recession : Expansionary fiscal policy

We know that as a result of the COVID 19 pandemic, many countries have fallen in a recession. There was a significant negative economic impact on the economy of Canada as results of the COVID 19 pandemic. As I mentioned above, when economy is in a recession, we should apply expansionary fiscal policy.

we will consider how the government of Canada has used it.

How expansionary fiscal policy can work?

Expansionary fiscal policy always increases aggregate demand. Because we know that aggregate demand is comprised of four factors. They are private consumption, private investment, government expenditure, and net export. Increasing any factor from these four, can increase the aggregate demand of a nation. So, increasing government expenditure means increasing the aggregate demand of a nation. In other words, the aggregate demand curve will shift to the right. Then the equilibrium output of the economy will shift to a new point which is greater than the previous combination of output. This means there will be an expansion of the economy and the economic growth rate will increase.

Expansionary fiscal policy can be used when an economy is in a recession position. So, the government of Canada has applied this theory to recover the economy.

Example of expansionary fiscal policy: Actions are taken by the government of Canada

As of end-June 2021 Canada had more than 1.4 million cases of COVID-19 and more than 26,200 deaths. Canada has distributed the amount which is $435.2 billion CAD (19.7% of GDP) for spending and tax measures. Kindly click here to see IMF data.

From that,

  • Distributed for $60.3 CAD billion (2.7% of GDP) for the health system (testing, vaccination, healthcare suppliers, mitigation efforts and, increased support of indigenous communities.
  • Approximately $290 billion (13.2% GDP) of direct support for households and businesses including salary subsidies, non-sick leave payment and employment insurance, increased GST tax credits and child care benefit, and a new Indigenous Community Support Fund based on distinctions.
  • Liquidity support by tax deferrals of about $85 billion (3.9 % of GDP)

Graphical presentation of the expansionary fiscal policy implementation of Canada

Following AD-AS diagram will clearly explain the expansionary fiscal policy implemented by Canada. To read more about AD-AS model, kindly click here. Assume that under the COVID 19 pandemic, economy of the Canada lays within point E1 which the equilibrium of aggregate demand 1(AD1) and short run aggregate supply 1 (SRAS 1) curves. Aggregate demand means, total demand for goods and services within a particular economy, and aggregate supply means the total supply of goods and services within a particular economy. At the point where aggregate demand equals aggregate supply, the economy produces the equilibrium output. Because at this point there is no excess demand or excess supply for the goods and services.

As I have mentioned above, the government of Canada has increased the government expenditure and then the aggregate demand curve has shifted rightward. It presents from AD2. So, new equilibrium of the economy lay on the point E2. New equilibrium price is P2 and new equilibrium quantity is Q2.

expansionary fiscal policy graph
Expansionary fiscal policy implementation.

Fiscal Policy for Recession and Keynesian Theory

Also, we can identify this macro-economic theory implementation as the “Keynesian Theory Application”. According to world-famous economist John Maynard Keynes, when an economy is in a recession or crisis, the government should apply the expansionary fiscal policy to increase the aggregate demand force. Ultimately the economy will be recovered.

But governments of the countries apply this theory still. Another latest example of the application of the Keynesian theory by the countries in the world is the 2008 – 2009 financial crisis in the world.. In the COVID-19 pandemic also most of the countries in the world applied Keynesian theory. Canada is one of the countries that applied Keynesian theory with the goal of recovering the economy. To read more about Keynesian economics, kindly click here

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