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Jan 5, 2023 · A contractionary policy is a monetary measure to reduce government spending or the rate of monetary expansion by a central bank. It is a macroeconomic tool used to combat rising inflation.
Jan 20, 2022 · Contractionary fiscal policy is decreased government spending or increased taxation. Here are examples, how it works, and why it's seldom used.
- Kimberly Amadeo
Expansionary fiscal policy occurs when the Congress acts to cut tax rates or increase government spending, shifting the aggregate demand curve to the right. Contractionary fiscal policy occurs when Congress raises tax rates or cuts government spending, shifting aggregate demand to the left.
Contractionary fiscal policy is expected to reduce interest rates, leading to additional investment, and weaken the U.S. dollar, leading to more U.S. exports and fewer imports and a slowing of inflation.
Expansionary fiscal policy includes either increasing government spending or decreasing taxes. An economy that is producing too much needs to be contracted. In that case, contractionary fiscal policy (either decreasing government spending or increasing taxes) is the correct choice.
A contractionary fiscal policy might involve a reduction in government purchases or transfer payments, an increase in taxes, or a mix of all three to shift the aggregate demand curve to the left. Figure 27.9 illustrates the use of fiscal policy to shift aggregate demand in response to a recessionary gap and an inflationary gap.
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What is a contractionary fiscal policy?
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Fiscal policy that increases aggregate demand directly through an increase in government spending is typically called expansionary or “loose.” By contrast, fiscal policy is often considered contractionary or “tight” if it reduces demand via lower spending.
