Impact of Expansionary Fiscal Policy

Readers Question: what are the impacts of expansionary fiscal policy?

Expansionary fiscal policy involves government attempts to increase Aggregate demand. It will involve higher government spending and  / or lower tax. In theory, higher government spending will increase Aggregate Demand and lead to higher economic growth.

However, the impact of expansionary fiscal policy will depend on many factors

• What else is happening in the economy? E.g. US tried to cut taxes in 2008. However, the economy is experiencing falling house prices and a credit crunch so expansionary fiscal policy is relatively ineffective.
• Does crowding out occur? Expansionary fiscal policy involves higher spending and more government borrowing; it could cause crowding out so private sector have less to spend.
• How much spare capacity is there in economy? e.g. in the above diagram the economy is near full capacity so inflation occurs.

Does Fiscal Policy solve unemployment?