Log out Go to App
Go to App

Learning Materials

Features

Discover

Chapter 11: Problem 18

Explain how, under certain conditions, expansionary fiscal policy can destabilize the economy.

Short Answer

Expert verified
An expansionary fiscal policy, consisting of increased government spending and reduced taxes, can destabilize the economy when it induces inflation due to demand-pull effect or when it crowds out investment by increasing interest rates. Moreover, an excessive stimulus can push the economy past its long-term trend line leading to a boom-bust cycle.

Step by step solution

01

Understand Expansionary Fiscal Policy

Expansionary fiscal policy is a type of fiscal policy that involves increasing government expenditures, decreasing taxes, or both, in order to stimulate economic growth or fight off recessionary pressures.
02

Understand Economic Stability

Economic stability refers to an economy that experiences constant growth and low inflation or deflation. Destabilize thus implies that these results are not produced, causing things like erratic growth, high inflation, deflation, high unemployment, etc.
03

Illustrate How the Policy Can Destabilize the Economy

By increasing government spending or decreasing taxes, expansionary fiscal policy boosts production and employment, and thus increases income and consumer spending. This leads to increased demand. However, if the economy is already close to full employment, this demand-pull can lead to inflationary pressures as businesses raise prices. The increased borrowing by the government to finance its expenditures can also crowd out investment by increasing interest rates (crowding out effect). Both cases cause destabilization. Another scenario is the overshooting scenario, where stimulus leads the economy past its long-term trend line causing a boom-bust cycle.

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

What is the difference between government expenditures and government purchases?

According to Buchanan and Wagner, why is there a political bias toward expansionary fiscal policy and not contractionary fiscal policy?

Is it true that, under a proportional income tax structure, a person who earns a high income will pay more in taxes than a person who earns a low income? Explain your answer.

What is the difference between a structural deficit and a cyclical deficit?

Identify and explain the five lags associated with fiscal policy.
See all solutions

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.

Sign-up for free