Expansionary Vs. Contractionary Fiscal Policy

A government’s fiscal policy involves increasing/decreasing spending and taxes to control the economy. The governments fiscal actions are reflected in the fiscal budget.

When the taxes collected are more than the spending, there’s a budget surplus. Similarly when spending exceeds tax collection, there’s a budget deficit.

Whether the fiscal policy is expansionary or contractionary can be gauged by whether there is budget surplus or budget deficit. The basic rules are given below:

  • Increase in surplus indicates contractionary fiscal policy
  • Decrease in surplus indicates expansionary fiscal policy
  • Increase in deficit indicates expansionary fiscal policy
  • Decrease in deficit indicates expansionary fiscal policy

An increase in surplus indicates that the increase in tax revenue is more than the increase in spending, which indicates contraction.

Even though the fiscal deficit provides some indication about the direction of fiscal policy, it may not indicate the true intention of the government with respect to its fiscal policy. For example, if the government is in recession, and its taking actions to expand the economy, the government is aiming for an expansionary policy. However, the current economic conditions may not truly reflect that. Therefore, to understand the true impact of the fiscal policy, the economists adjust the budget for cyclical issues.

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