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ACCA Applied Skills · Financial Management · The economic environment for business

A government wants to reduce unemployment during a recession and decides to use expansionary fiscal policy. Which of the following combinations of actions is most consistent with this aim?

Expansionary fiscal policy means higher government spending and lower taxes, typically funded by borrowing, to raise aggregate demand and reduce unemployment. Cutting spending and raising taxes is contractionary, and interest rate and money supply changes are monetary policy rather than fiscal policy.

  1. AIncrease government spending and reduce income tax rates, financed by borrowingCorrect
  2. BReduce government spending and increase income tax rates to cut the budget deficit
  3. CRaise interest rates and reduce the money supply to control inflation
  4. DIncrease government spending while raising taxes by the same amount

Explanation

Expansionary fiscal policy raises aggregate demand by increasing government spending and/or cutting taxes, which usually widens the budget deficit and is financed by borrowing. Option B is contractionary fiscal policy. Option C describes monetary policy, not fiscal policy. Option D is a balanced budget change, which has a much smaller net stimulus.

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