Fiscal Policy
| English | Chinese | Pinyin |
|---|---|---|
| fiscal policy | 财政政策 | cái zhèng zhèng cè |
| expansionary | 扩张性 | kuò zhāng xìng |
| contractionary | 紧缩性 | jǐn suō xìng |
Speeding up the cure
- Self-adjustment eventually works, but it can be painfully slow — years of high unemployment.
- So the government often acts deliberately to speed things up.
- It uses its own spending and taxes to steer aggregate demand.
- This is fiscal policy 财政政策.
Expansionary fiscal policy
- Expansionary 扩张性 fiscal policy increases AD: the government raises spending or cuts taxes.
- More spending adds directly to $G$; a tax cut leaves households more to spend, raising $C$.
- AD shifts right.
- Use it to fight a recessionary gap.
Fiscal policy in the AD-AS model
Expansionary fiscal policy shifts AD right to close a recessionary gap; contractionary policy shifts AD left to cool an inflationary gap.
Expansionary fiscal policy means the government:
More spending or lower taxes shifts AD right — used to fight a recessionary gap.
Select all tools of fiscal policy.
Fiscal policy works through spending, taxes and transfers; the money supply is monetary policy.
Contractionary fiscal policy
- Contractionary 紧缩性 fiscal policy decreases AD: the government cuts spending or raises taxes.
- AD shifts left.
- Use it to cool an inflationary gap and tame demand-pull inflation.
- Match the tool to the gap: recessionary → expansionary; inflationary → contractionary.
Match each gap to the right fiscal policy.
Push AD toward potential: right for a recession, left for an inflationary boom.
To cool an inflationary gap, the government uses contractionary fiscal policy (cut spending or raise taxes).
Contractionary policy shifts AD left, back toward potential output.
Powered by the multiplier
- Fiscal policy is powerful because of the multiplier — the government need not close the whole gap by itself.
- $\Delta \text{GDP} = \text{spending multiplier} \times \Delta G$.
- Worked idea. A recessionary gap is 200b and $MPC = 0.8$, so the spending multiplier is 5.
- To close the gap, $\Delta G = 200 \div 5 = 40$b — just 40b of spending, magnified fivefold.
A recessionary gap is 200 and the spending multiplier is 5. How much extra government spending closes it?
ΔG = gap ÷ multiplier = 200 ÷ 5 = 40 — magnified fivefold to shift AD by 200.
To close the same gap, a tax cut must be larger than a spending rise because:
The tax multiplier is smaller than the spending multiplier, so a bigger tax change is needed.
Fiscal policy uses government spending and taxes to steer AD. Expansionary (more spending / lower taxes) shifts AD right to fight a recessionary gap; contractionary (less spending / higher taxes) shifts AD left to cool an inflationary gap. The multiplier magnifies each action.