The economy is characterized by high unemployment, low inflation, and low aggregate demand during a recession. Expansionary fiscal and monetary policy tools can be employed to lift the economy out of a slump and stimulate economic growth by increasing aggregate demand. Expansionary policy instruments are successful at increasing disposable income and aggregate demand, as well as increasing government spending on the general public and investment.
Inflation is currently at 0.4%, while unemployment is at 9%. Higher rates of inflation (around the historical average rate of inflation) are required to stimulate economy by encouraging investors and workers to work harder. Expansionary fiscal policy tools will be increased government spending and reduced taxes. Increased spending in provision of public goods and infrastructural development creates more job opportunities to the citizens and increases disposable income. On the other hand, tax reduction on income increases the amount of disposable income that are used for consumption and investment expenditures. As an expansionary fiscal tool, reduction of taxes on personal income increases aggregate demand and investment level in an economy. The diagram below shows the application of expansionary monetary and fiscal policy tools in removing an economy from recession.
Expansionary fiscal policies are effective in controlling the amount of money circulating in the economy, interest, and inflation rates to ensure that effective demand of money is created at any time. Expansionary tools like open market operations, reserve requirement, and interest rates can be used to increase money demand and supply during recession. Using the open market operations as a tool, the government through the central bank should buy the treasure bonds and shares from the public to increase the amount of money in circulation. Reducing the reserve requirement and interest rates increases the amount of loanable funds available in the commercial banks for borrowing by the public. Increased rates will discourage savings and encourage investments thereby stimulating growth and creating employment opportunities.
