How to Close a Recessionary Gap Using Fiscal Policy

Expansionary Fiscal Policy to Close a Recessionary Gap

Expansionary fiscal policy involves actions taken by the government to increase aggregate demand and close a recessionary gap. In this case, with a recessionary gap of $1,000 million and a MPC of 0.8, the government can implement expansionary fiscal policy to stimulate economic growth.

Expansionary fiscal policy includes measures such as tax cuts, increasing transfer payments, and boosting government spending on projects like infrastructure development. By injecting more money into the economy through these actions, the government aims to boost consumer and business spending, thus closing the recessionary gap.

However, it's important to note that while expansionary fiscal policy can be effective in stimulating economic activity, it may also lead to certain drawbacks. These can include higher interest rates, increased trade deficits, and rising inflation rates if implemented during strong economic conditions.

The potential negative effects of expansionary fiscal policy may offset some of its intended benefits. Governments typically use this policy tool to counter downturns in the business cycle and prevent economic recessions by bolstering overall demand.