Identify whether expansionary or contractionary fiscal polic

Identify whether expansionary or contractionary fiscal policy, or no policy intervention at all, would seem to be most appropriate in response to each of the situations below. Explain your answers please

1. A stock market collapse that hurts consumer and business confidence.

2. Extremely rapid growth of exports.

3. Quickly rising inflation.

4. A decrease in the natural rate of unemployment.

5. A rapid rise in oil prices.

Solution

a) When there is a collapse in the market the government need to increase the government expenditure i.e. use an expansionary fiscal policy. As the government expenditure is part of Aggregate demand it will increase the demand in the economy.

b) With a rapid growth of exports, the inflation will rise in the economy. In such a situation the government will need to adopt a contractionary fiscal policy.

c) Quickly rising inflation will hurt the real income of the people to reduce the inflation the government needs to reduce the money in hand. They will increase the taxes and reduce the expenditure. Adopt a contractionary fiscal policy.

d) With a decrease in the natural rate of unemployment, the economy will demand more than the supply this will again lead to inflation and the government will need to adopt a contractionary fiscal policy.

e) A rapid rise in oil will make the input of the production costlier and increase the price of the goods. If the government increase the expenditure it will lead to further inflation and if the reduce the expenditure it will increase the unemployment. The government should leave the market as it is i.e. no intervention at all.