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Chapter 13: Problem 5

Is expansionary fiscal policy always effective at increasing total spending in the economy and decreasing unemployment? Explain your answer

Short Answer

Expert verified
Though expansionary fiscal policy can increase total spending and decrease unemployment, this is not always the case due to various factors such as timing, crowding out effects, interest rates, and liquidity traps.

Step by step solution

01

Understanding Expansionary Fiscal Policy

Start by defining what an expansionary fiscal policy is. Expansionary fiscal policy is a macroeconomic policy tool used by a country's government to stimulate its economy. The most common methods are increasing government spending and decreasing taxes. The aim of this policy is to expand the money supply in the economy, increase total demand or spending, and reduce unemployment rates.
02

Explaining the Effectiveness of Expansionary Fiscal Policy

Explain how this policy operates under normal circumstances. When a government increases its spending or reduces taxes, consumers have more income to spend. This increase in consumer spending will boost total spending in the economy and lead to the creation of jobs, reducing unemployment.
03

Exploring Limitations of Expansionary Fiscal Policy

However, the effectiveness of this policy is not always guaranteed. Several factors such as timing, crowding out effect, increasing long term interest rates due to increasing public debt, or a liquidity trap scenario where consumers prefer to hold onto their money rather than spend can limit or nullify the intended effects of an expansionary fiscal policy.

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Most popular questions from this chapter

In the past how did economists view the relationship between unemployment and inflation? When did economic events begin to change this view?

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