Expansionary Fiscal and Monetary policy







Introduction3

Expansionary Fiscal policy3

Government Expenditure3

Taxation4

Effect on GDP and employment level4

Expansionary monetary policy5

Government Securities6

Discount rate and Interest rate6

Effect upon Aggregate demand and GDP6

Effect upon Employment level7

Required Reserve ratio7

Desired results8

Conclusion8

References9

Expansionary fiscal and monetary policy

Introduction

The government makes use of two policies in trying to resolve the problems regarding the business cycle contractions, a scenario in which there is high unemployment and low economic growth, plus in order to avoid the chances of potential contractions in the economy. The two policies are known as Expansionary fiscal policy and Expansionary monetary policy, which would be as follows. However it must be taken into account that these expansionary policies are implemented to prosper the chances of economic growth, with low unemployment and a stable price level.

Expansionary Fiscal policy

The implementation of expansionary fiscal policy would involve an increase in government expenditure, a decrease in taxes, and if necessary an increase in transfer payments. The goal of this policy is close a recessionary gap, a situation where the economy is producing at a level which is below its desired level. Therefore, the economy needs a certain push so that it could attain its true potential, as it is done through these policies.

Government Expenditure

Firstly, the government comes into play and tries to boost the economy through its expenditures. The expenditures are the ones on final goods and services; it could involve large expenditures on air planes or even smaller expenditures such as on fixtures and fittings. Over the years, this is the tool, which has been used to a great extent by the government.

However, there is a drawback attached to a rise in government expenditure. It leads to an increase in the extent of the resources being owned by the government, whereas there shall be a limited role of the government in the production of goods and services. Due to the fact that, government is often responsible for an ineffective utilization of resources, due to the fact that profit maximization is not their ultimate goal.

Taxation

Secondly, the government uses the tool of Taxation for the purpose of expansionary fiscal policy. There are two types of taxation, one being direct taxation and the other being indirect taxation. Direct taxation is the one where the incidence, or rather the burden, of tax cannot be shifted. Income tax is an example of direct taxation.

On the other hand, indirect taxation is one where the incidence cannot be shifted, taxes on consumption is an example of it. However direct tax (income tax) is the one which is used on most of the occasions. The government or the tax authorities would need to decrease the tax rate so that the disposable income of the individual would go up and he is able to spend more as compared to before.

Effect on GDP and employment level

Expansionary fiscal policy would have a significant impact upon the economy. Through the increase in government expenditure, a component in the Aggregate Demand (AD) function (as follows), ...