Expansionary Fiscal Policy

Reviewed by Bhavana | Updated on Aug 01, 2021



Expansionary fiscal policy is when the government increases the money supply in the economy using budgetary instruments to either raise spending or cut taxes—both having more money to invest for customers and companies.

Objective of Expansionary Fiscal Policy

Expansionary fiscal policy is intended to boost growth to a healthy economic level, which is required during the business cycle's contractionary period. The government seeks to reduce unemployment, raise consumer demand, and stop the recession. Once a recession has already arisen, it intends to end the recession and prevents depression.

How Does it Function?

By utilising subsidies, transfer payments (inclusive of welfare programs), and tax cuts on wages, expansionary fiscal policy brings more money into the hands of consumers to give them more purchasing power.

It also lowers unemployment by contracting public works or recruiting new government employees, all of which raise demand and boost consumer spending driving nearly 70 per cent of the economy. The other three components of the gross domestic product are government expenditure, net exports, and investment by industry.

Cutting corporate taxes put more money into the hands of companies, which the government hopes would be diverted into new projects and growing employment. Tax cuts generate employment in this way, so if the company already has enough cash, it can use the cut to buy back stocks or purchase new businesses.

The supply-side economics theory suggests reducing corporate taxes rather than payroll taxes and supports lower capital gains taxes to boost spending by companies.

Expansionary Fiscal Policy Examples

The two significant examples include increased government spending as well as tax cuts. These policies seek to raise aggregate demand while leading to deficits or drawing the decline of budget surpluses. They are employed during recessions or in the midst of one's worries to spur a recovery or head off a recession.

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