Fiscal Policy Approaches Quiz

Expansionary fiscal policy aims to boost economic growth by increasing government spending and/or reducing taxes.

Monetary policy refers to the management of money supply and interest rates by a central bank, whereas fiscal policy involves government decisions regarding taxation and spending.

Contractionary fiscal policy aims to reduce inflationary pressures by decreasing government spending and/or increasing taxes, thereby reducing aggregate demand.

During economic downturns, governments may use expansionary fiscal policy by increasing government spending to stimulate economic growth and boost aggregate demand.

One limitation of expansionary fiscal policy is the potential for increased government borrowing, which can result in higher levels of public debt.

Contractionary fiscal policy involves reducing government spending and/or increasing taxes to curb inflationary pressures.

One drawback of fiscal policy is the potential for increased government borrowing, which can lead to higher levels of public debt.

During a recession, governments may implement expansionary fiscal policy by increasing spending on infrastructure, education, or social programs to stimulate economic activity.

Fiscal policy affects aggregate demand by altering government spending and taxation levels, which in turn impact consumption, investment, and net exports.

Automatic stabilizers are mechanisms that automatically increase government spending or decrease taxes during economic downturns, helping to stabilize the economy without requiring explicit government action.

Discretionary fiscal policy involves deliberate actions by the government, such as changes in spending or taxation, whereas automatic stabilizers are built-in features of the economy that automatically adjust government spending and taxation in response to economic conditions.

The crowding-out effect occurs when increased government borrowing leads to higher interest rates, reducing private sector investment.

The Ricardian equivalence proposition suggests that changes in government borrowing have no impact on aggregate demand because individuals expect future taxes to offset current deficits.

A liquidity trap occurs when nominal interest rates are near zero, limiting the effectiveness of monetary policy and making fiscal policy less potent in stimulating the economy.