What Is the Difference Between Contractionary & Expansionary Monetary Policy? Both affect the demand and supply of goods and services in the economy which describes the economic graph. Figure 2. "What Is The Difference Between Contractionary And Expansionary Fiscal Policies Which Is More Appropriate Today Explain Your Answer How Might Contractionary And Expansionary Fiscal Policies Affect" Essays and Research Papers . Both policies are interventions which regulate the direction of an economy. Expansionary Monetary Policy under Floating Exchange Rate: Increase in NX will lead to an increase in AD (because NX is a component of AD) and this will in turn lead to an increase in the income level from Y 1 to Y 2. You can view the transcript for “Macro: Unit 3.1 — Types of Fiscal Policy” here (opens in new window). What is the difference between contractionary and expansionary fiscal policy? My Nursing Term Papers. The intersection of aggregate demand (AD0) and aggregate supply (AS0) occurs at equilibrium E0. Again, the AD–AS model does not dictate how this contractionary fiscal policy is to be carried out. The GDP gap is defined as the difference between potential GDP and actual GDP, when both are measured in real terms. The insight and firsthand experience of our writers will make your dream come true. increasing government purchases through increased spending by the federal government on final goods and services and raising federal grants to state and local governments to increase their expenditures on final goods and services. The economy starts at the equilibrium quantity of output Yr, which is above potential GDP. Choose the payment system that suits you most. Thus expansionary fiscal policy becomes ineffective in increasing the income level. Figure 1 uses an aggregate demand/aggregate supply diagram to illustrate a healthy, growing economy. The choice between whether to use tax or spending tools often has a political tinge. Expansionary fiscal policy occurs when the Congress acts to cut tax rates or increase government spending, shifting the aggregate demand curve to the right. In this Buzzle article, you will come across the pros and cons of using expansionary and contractionary fiscal policy. The paper will be accustomed to your specification and to the format of your choice. Contractionary fiscal policy is the opposite of expansionary fiscal policy. The fiscal policy is administered and announced by the Ministry of Finance. Watch the selected clip from this video to learn more about the ways that government can implement fiscal policies. We’d love your input. After the Great Recession of 2008–2009, U.S. government spending rose from 19.6% of GDP in 2007 to 24.6% in 2009, while tax revenues declined from 18.5% of GDP in 2007 to 14.8% in 2009. At the equilibrium (E0), a recession occurs and unemployment rises. Expansionary fiscal policy is implemented by reducing taxes and increasing government expenditure while contractionary fiscal policy works by increasing taxes and reducing government expenditure. One year later, aggregate supply has shifted to the right to AS1 in the process of long-term economic growth, and aggregate demand has also shifted to the right to AD1, keeping the economy operating at the new level of potential GDP. Modification, adaptation, and original content. The aggregate demand/aggregate supply model is useful in judging whether expansionary or contractionary fiscal policy is appropriate. The government decreases government spending and increases taxes. Suppose the macro equilibrium occurs at a level of GDP above potential, as shown in Figure 3. Fiscal Policy in the United States. Figure 1. The intersection of aggregate demand (AD0) and aggregate supply (AS0) is occurring below the level of potential GDP. Expansionary fiscal policy increases the level of aggregate demand, through either increases in government spending or reductions in taxes. The Obama administration and Congress passed an $830 billion expansionary policy in early 2009 involving both tax cuts and increases in government spending, according to the Congressional Budget Office. Monetary Policy vs. Fiscal Policy: An Overview . Expansionary and contractionary are two types of fiscal policy. Figure 3. Compare and contrast expansionary and contractionary fiscal policy. The original equilibrium (E0) represents a recession, occurring at a quantity of output (Yr) below potential GDP. This is accomplished by the government deliberately making changes " in either government spending or taxes to stimulate or slow down the economy" (Colander, 2004, p. 583). Whether the fiscal policy is expansionary or contractionary can be gauged by whether there is budget surplus or budget deficit. In such a situation, the government limits its rate of spending. In addition, the price level would rise back to the level P1 associated with potential GDP. The Great Recession meant less tax-generating economic activity, which triggered the automatic stabilizers that reduce taxes. This very large budget deficit was produced by a combination of automatic stabilizers and discretionary fiscal policy. First, they both represent a nation’s policies to regulate its economy. Expansionary fiscal policy occurs when the Congress acts to cut tax rates or increase government spending, shifting the aggregate demand curve to the right. Question: Compare And Contrast Expansionary And Contractionary Fiscal Policy. Expansionary and contractionary fiscal policies raise and lower money supply, respectively, into the economy. Explain the Keynesian logic for expansionary and contractionary fiscal policy for reducing unemployment and inflation; The GDP Gap. Monetary policy and fiscal policy refer to the two most widely recognized tools used to influence a nation's economic activity. Discretionary fiscal policy requires government action through Congress to make changes in spending or taxation; automatic stabilizers use spending in the form of transfer payments and taxation in the form of progressive income taxes to steady the economy automatically. Most economists, even those who are concerned about a possible pattern of persistently large budget deficits, are much less concerned or even quite supportive of larger budget deficits in the short run of a few years during and immediately after a severe recession. This increase in spending will increase the aggregate demand curve as it allows customers to have more money at their disposal to consume and invest. Fiscal policy can also be used to slow down an overheating economy. For example, investment by private firms in physical capital in the U.S. economy boomed during the late 1990s, rising from 14.1% of GDP in 1993 to 17.2% in 2000, before falling back to 15.2% by 2002. Generally speaking contractionary monetary policies and expansionary monetary policies involve changing the level of the money supply in a country. Conversely, increases in aggregate demand could run ahead of increases in aggregate supply, causing inflationary increases in the price level. The governments fiscal actions are reflected in the fiscal budget. Ultimately, decisions about whether to use tax or spending mechanisms to implement macroeconomic policy is, in part, a political decision rather than a purely economic one. The conflict over which policy tool to use can be frustrating to those who want to categorize economics as “liberal” or “conservative,” or who want to use economic models to argue against their political opponents. Did you have an idea for improving this content? A fiscal policy is a government intervention to control the economy. You will get a personal manager and a discount. Please Note: Do not get confused between fiscal policy and monetary policy. Consumers’ reaction to these policies may be positive or negative. What is the difference between contractionary and expansionary fiscal policy? It is a powerful tool to regulate macroeconomic variables such as inflation and unemployment.. In short, the figure shows an economy that is growing steadily year to year, producing at its potential GDP each year, with only small inflationary increases in the price level. Give us a go! In this situation, contractionary fiscal policy involving federal spending cuts or tax increases can help to reduce the upward pressure on the price level by shifting aggregate demand to the left, to AD1, and causing the new equilibrium E1 to be at potential GDP. transcript for “Macro: Unit 3.1 — Types of Fiscal Policy” here (opens in new window), https://cnx.org/contents/vEmOH-_p@4.44:T6rLOl1i@4/Using-Fiscal-Policy-to-Fight-R, https://www.youtube.com/watch?v=q-j8AUCLKgw, Explain how expansionary fiscal policy can increase aggregate demand and boost the economy, Explain how contractionary fiscal policy can decrease aggregate demand and depress the economy. We believe that all students should have a chance to finish medical school. 250 words. They are two different terms. How might contractionary and expansionary fiscal policy affect the healthcare organization? Each year, the economy produces at potential GDP with only a small inflationary increase in the price level. Differences between expansionary and contractionary fiscal policy on aggregate demand: Expansionary fiscal policy: increasing consumption by raising disposable income through cuts in personal income taxes or payroll taxes; increasing investments by raising after-tax profits through cuts in business taxes; and. As a general statement, conservatives and Republicans prefer to see expansionary fiscal policy carried out by tax cuts, while liberals and Democrats prefer that expansionary fiscal policy be implemented through spending increases. There are two main types of expansionary policy – fiscal policy and monetary policy Monetary Policy Monetary policy is an economic policy that manages the size and growth rate of the money supply in an economy. In the real world, however, aggregate demand and aggregate supply do not always move neatly together, especially over short periods of time. Similarities between the expansionary and contractionary fiscal policy: In both situations, implementation takes time due to legislative and administrative processes. Changes in Government spending 2. Similarities between the expansionary and contractionary fiscal policy: Differentiate between expansionary and contractionary fiscal policy Fiscal policy consists of: 1. Let us suppose that there is a recession in a country. Expansionary fiscal policy, on the other hand, is often thought to lead to increases in interest rates. Explain The Difference Between Contractionary Fiscal Policy And Expansionary Fiscal Policy 3. Contractionary fiscal policy occurs when Congress raises tax rates or cuts government spending, shifting aggregate demand to the left. But the AD–AS model can be used both by advocates of smaller government, who seek to reduce taxes and government spending, and by advocates of bigger government, who seek to raise taxes and government spending. On the other hand, the monetary policy is announced by the central bank. Differentiate Between Expansionary Fiscal Policy and Contractionary Fiscal Policy Maira Jzas. Similarly when spending exceeds tax collection, there’s a budget deficit. Which do you think is more appropriate today? When the government observes unwanted inflationary trends, it can arrest or reduce such a trend by reducing its expenditure in relation to its tax revenue for the year. Any citation style (APA, MLA, Chicago/Turabian, Harvard). In this case, expansionary fiscal policy using tax cuts or increases in government spending can shift aggregate demand to AD1, closer to the full-employment level of output. Japan used expansionary fiscal policy to help get them out of that terrible economic situation. Automatic stabilizers, which we learned about in the last section, are a passive type of fiscal policy, since once the system is set up, Congress need not take any further action. When the economy is in recession, the expansionary fiscal policy is in order and the aggregate demand is a level lower than it would be in a full employment situation. similarities between contractionary and expansionary fiscal policy Posted by October 5, 2020 Leave a comment on similarities between contractionary and expansionary fiscal policy | A decrease in spending will decrease the aggregate demand curve as consumers will have less money to invest and consume. (using Microsoft Word, Times New Roman or Aerial, 12-point font, 1 inch margins, single or double space). But if aggregate demand does not smoothly shift to the right and match increases in aggregate supply, growth with deflation can develop. Both affect the demand and supply of goods and services in the economy which describes the economic graph. The original equilibrium occurs at E0, the intersection of aggregate demand curve AD0 and aggregate supply curve AS0, at an output level of 200 and a price level of 90. When the taxes collected are more than the spending, there’s a budget surplus. This could be caused by a number of possible reasons: households become hesitant about consuming; firms decide against investing as much; or perhaps the demand from other countries for exports diminishes. Fiscal policy is the use of government spending and tax policy to influence the path of the economy over time. We deliver what we promise and we deliver it fast! Consider first the situation in Figure 2, which is similar to the U.S. economy during the recession in 2008–2009. The shifting of demand curve to the right will help the economy to grow. A discretionary fiscal policy is a type of active policy incorporating contractionary and expansionary measures to slow or speed up the growth of the economy. Explain What Is "Fiscal Lags" And How They Relate To Fiscal Policy Giving At Least Two (2) Examples With Explanations. The fiscal policy is the record of the revenue generated through taxes and its division for the different public expenditures. In 2011, Japan suffered from a natural disaster. The difference between expansionary and contractionary fiscal policy is that one is meant to make the economy expand and the other is meant to make it slow down. Each phase of the business cycle comes with its … This can be represented as a shift to the left of the AD curve, reducing the equilibrium output of … A Healthy, Growing Economy. Fiscal policy and monetary policy are similar in two aspects. The model only argues that, in this situation, aggregate demand needs to be reduced. In this well-functioning economy, each year aggregate supply and aggregate demand shift to the right so that the economy proceeds from equilibrium E0 to E1 to E2. This is referred to as an expansionary fiscal policy. Should the government use tax cuts or spending increases, or a mix of the two, to carry out expansionary fiscal policy? The Difference Between Expansionary and contractionary Monetary Policies: The business cycle is marked by growth and recessions. Expansionary Fiscal Policy. How might contractionary and expansionary fiscal policy affect the healthcare organization? 481 - 490 of 500 . Some may prefer spending cuts; others may prefer tax increases; still others may say that it depends on the specific situation. Expansionary monetary policy is simply a policy which expands (increases) the supply of money, whereas contractionary monetary policy contracts (decreases) the supply of a country's currency. The north east area of the country was struck by a tsunami causing their country to endure financial issues. Contractionary fiscal policy: Contrary to this, the monetary policy maintains and regulates the money supply within the economy. Follow these simple steps to get your paper done. 1. Changes in tax collection The fiscal policy can be defined as discretionary (‘active’) Discretionary changes in government spending and taxes are at the option of the government, they do not occur automatically. Expansionary fiscal policy helped Japan by raising thei… As these occur, the government may choose to use fiscal policy to address the difference. 3. Conversely, the decision to reduce government spending is contractionary. See the answer. Once your paper is ready, we will email it to you. Alex Kocic - Updated March 23, 2017 Both contractionary and expansionary monetary policies are tools available to a country's central bank whose aim is to reduce or increase the money supply and … A Contractionary Fiscal Policy. (The macroeconomy can be usefully split into aggregate supply, and aggregate demand.) This problem has been solved! However, state and local governments, whose budgets were also hard hit by the recession, began cutting their spending—a policy that offset federal expansionary policy. In order to remove this inflationary gap, the government may reduce its spending and increase the taxes. Business cycles of recession and boom are the consequence of shifts in aggregate supply and aggregate demand. Fiscal policy is the process the government uses to determine the appropriate level of taxes and spending necessary to deal with recessions, inflation, and unemployment. A decrease in spending will decrease the aggregate demand curve as consumers will have less money to invest and consume. When an economy is in a state where growth is getting out of control, contractionary fiscal policy comes into function. Contractionary fiscal policy happens when the government and its public agencies lowers its expenditures, while also decreasing spending or increasing taxes at the same time. One more year later, aggregate supply has again shifted to the right, now to AS2, and aggregate demand shifts right as well to AD2. A contractionary fiscal policy is the opposite. Expert Answer . 2. This kind of recession results in increased government spending or lower tax rates. Aggregate demand may fail to grow as fast as aggregate supply, or it may even decline causing a recession. Explain your answer. This causes consumption to fall as purchasing power declines. Since the economy was originally producing below potential GDP, any inflationary increase in the price level from P0 to P1 that results should be relatively small. Fill in the order form and provide all details of your assignment. A government can reduce aggregate demand (And for that matter inflation) in an economy by adopting contractionery fiscal policy. Now, let us see how the monetary policy and fiscal policy impacts this unfavourable economic condition.Monetary PolicyIn case of recession, the expansionary monetary policy is applicable. Consumers’ reaction to these policies may be positive or negative. Expansionary policy involves raising government expenditures and lowering taxes so the government budget deficit can grow or the surplus to fall. Both monetary and fiscal policy, in macroeconomics, are methods of managing aggregate demand. Expansionary policy can do this by: Contractionary fiscal policy does the reverse: it decreases the level of aggregate demand by decreasing consumption, decreasing investments, and decreasing government spending, either through cuts in government spending or increases in taxes. Voters like both tax cuts and more benefits, and as a result, politicians that use … On the other hand, discretionary fiscal policy is an active fiscal policy that uses expansionary or contractionary measures to speed the economy up or slow the economy down. Using Fiscal Policy to Fight Recession, Unemployment, and Inflation. Expansionary policy is used more often than its opposite, contractionary fiscal policy. Now the equilibrium is E2, with an output level of 212 and a price level of 94. Types of Expansionary Policy. Contracrionery and expansionary fiscal policies are like two opposite poles. Topic: Similarities and differences between the effect of expansionary and contractionary fiscal policy on aggregate demand. Question: 2. In both situations, implementation takes time due to legislative and administrative processes. Contractionary Fiscal Policy: Fiscal policy can also be used to address inflationary problems created by an overheated business-cycle expansion. This is the opposite of expansionary policy. The extremely high level of aggregate demand will generate inflationary increases in the price level. (The figure uses the upward-sloping AS curve associated with a Keynesian economic approach, rather than the vertical AS curve associated with a neoclassical approach, because our focus is on macroeconomic policy over the short-run business cycle rather than over the long run.) 95 Economic studies of specific taxing and spending programs can help to inform decisions about whether taxes or spending should be changed, and in what ways. Another connection between fiscal policy and inflation can be seen in the effect that a contractionary fiscal policy has on the economy. Between monetary and fiscal policy, the former is generally viewed as having the largest impact on the economy, while fiscal policy is seen as being the less efficient way to influence growth trends. We can write the body of the paper to any length (pages), in addition we can include the title page, abstract, Introductory text, Conclusion, and references pages. Meaning increasing taxation or reducing government spending or both. However, a shift of aggregate demand from AD0 to AD1, enacted through an expansionary fiscal policy, can move the economy to a new equilibrium output of E1 at the level of potential GDP. It consists of decreasing government purchases, increasing … The new equilibrium (E1) is at an output level of 206 and a price level of 92. Contractionary fiscal policy occurs when Congress raises tax rates or cuts government spending, shifting aggregate demand to the left. Monetary policy, by construction, lowers interest rates when it seeks to stimulate the economy and raises them when it seeks to cool the economy down. Of recession and boom are the consequence of shifts in aggregate supply, growth with can! 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