Expansive fiscal policy


Expansive fiscal policy is a type of fiscal policy criterion that is characterized especially by two main features: an increase in public spending and a reduction in tax collection through tax cuts.

Increasing the items of public spending in the budget of a country or territory and a reduction in taxes in it are usually the most prominent measures of expansionary fiscal policy. They usually occur simultaneously, although it is possible that they occur on occasions without necessarily being taken at the same time.

Generally this type of policy is usually related to the concept of fiscal deficit. As the amount of public spending is greater than the bulk of taxes collected, the budget deficit increases. In other words, more money goes out in public services than what comes in as taxes.

Objectives of an expansionary fiscal policy

Expansive fiscal policies are usually applied when seeking to increase aggregate demand. These situations usually occur in difficult times. From an economic point of view, these are times when a push from the state is needed. An example of this are crises or recessions. Resorting to an increase in the public deficit is frequent through the application of these measures.

The increase in aggregate demand would consist of increases in production with the increase in the amount of public spending. A reduction in unemployment is being pursued thanks to cuts in the most common taxes, so that consequently other results are also achieved, such as greater consumption of goods and services and an increase in investment terms by companies. Another possible way to increase consumption and revive the economy could be helicopter money. See helicopter money

Economic history has shown that the abuse of this type of fiscal policy tends to lead to inflation and increasing periods of recession over time. However, its importance in the short term is also noteworthy. In times of crisis, the role assumed by governments helps their citizens to suffer less from its consequences. The downside to this aid is that it burdens the state's long-term resources by increasing the fiscal deficit.

Relationship between expansionary fiscal policy and inflation

As we have indicated previously, the abuse of expansionary fiscal policies can lead to inflation. In the case of applying an expansive monetary policy, it is easier to see. However, it is not so logical in the case of expansionary fiscal policies.

We must bear in mind that an expansionary fiscal policy aims to stimulate aggregate demand. In other words, boost economic activity. The two routes that are usually taken in this regard are:

  • Lower taxes: Lower taxes have the direct consequence of an increase in disposable income. The state assumes that it will collect less money via taxes, but it "sacrifices" itself for the common good. The population, thanks to lower taxes, has more disposable income. Having more disposable income increases consumption. Increased consumption causes companies to earn more. In theory, this would lead to a reduction in unemployment and an increase in wages. By economic theory, this produces an increase in prices. That is, it causes inflation.
  • Increase in public spending: On the other hand, we find public spending. Public spending can have many different paths. Public spending can be used to get into debt (and thus make up for the deficit created by lower taxes). At the same time, the state can borrow to invest in infrastructure and create jobs. Or even the state can increase public spending to subsidize businesses or increase unemployment benefits. All of this makes disposable income higher. By having more disposable income, consumption must increase and prices must rise. Ultimately, it can cause inflation.

Criticisms of expansionary fiscal policy

Although in theory it all makes sense, some economists indicate that the effects are not exactly those. It can happen, but it also may not happen. Theory is one thing and practice is another.

Therefore, the effects of an expansionary fiscal policy depend on many factors. For example, the production model, the level of indebtedness, the previous tax burden or the type of crisis.

Some of the most important criticisms of expansionary fiscal policy are listed below:

  • Trade deficit
  • Expulsion effect
  • Having more income does not have to increase consumption
  • May jeopardize long-term economic stability
Restrictive monetary policy Contractionary fiscal policy

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