Expansionary Fiscal Policy: Definition, Examples

What Sets Bush and Obama Apart From Clinton

expansionary monetary policy
President Barack Obama extends his hand to former President George W. Bush (C) as former President Bill Clinton (L) looks on in the Rose Garden of the White House January 16, 2010. Photo by Mark Wilson/Getty Images

Definition: Expansionary fiscal policy is when the government uses its budgeting tools to provided consumers and businesses with more money. These tools include increased spending, including transfer payments, or tax cuts. It usually uses a combination of all three. In the United States, Congress must generally approve these measures.

The government can increase discretionary spending, including military expenditures.

It can also raise payments in mandatory programs such as Social Security, Medicare, or welfare programs. Sometimes these payments are called transfer payments because they reallocate funds from taxpayers to targeted demographic groups. A transfer payment that's not a mandatory program is expanded unemployment benefits.

The government can cut any or all of the following taxes: income, capital gains taxes, taxes on small businesses, payroll taxes, and corporate income taxes

Purpose

The purpose of an eWithout that leadership, a recession could turn into a depression. Everyone would just stuff their money under their mattress.xpansionary fiscal policy is to boost growth to a healthy economic level during the contractionary phase of the business cycle. The government wants to reduce unemployment, increase consumer demand, and avoid a recession. If a recession has already occurred, then it seeks to end the recession and prevent a depression.

 

How It Works

Expansionary fiscal policy is so named because it expands the amount of money available for consumers and businesses to spend.

It puts more money into consumers' hands to give them more purchasing power. It uses subsidies,  transfers payments including welfare programs, and income tax cuts.

It reduces unemployment by contracting public works or hiring new government workers. All these measures increase demand. That boosts business profit. They use it for new investment and hiring to meet the increased demand. For more, see Do Tax Cuts Create Jobs?

The government also puts more money into businesses' hands. The theory of supply-side economics recommends lowering corporate taxes instead of income taxes. That gives companies funds to hire more workers. It advocates lower capital gains taxes to increase business investment. This type of Trickle Down Economics doesn't work unless tax rates are 50% or higher.  For more, see What Does the Laffer Curve Really Say?.

Examples

The Obama Administration used expansionary policy with the Economic Stimulus Act. It cut taxes, extended unemployment benefits, and funded public works projects. In 2010, he continued many of these benefits with the Obama tax cuts. He also increased defense spending. All this occurred while tax receipts dropped thanks to the 2008 financial crisis. For more, see National Debt Under Obama.

The Bush Administration correctly used expansive fiscal policy to end the 2001 recession. It cut incomes taxes with EGTRRA, and the tax rebates were mailed out.

However, the 9/11 terrorist attacks sent the economy back into a downturn. Bush boosted government defense spending with the War on Terror and cut business taxes in 2003 with JGTRRA. By 2004, the economy was in good shape, with unemployment at just 5.4%. However, Bush continued the expansionary policy, boosting defense spending with the War in Iraq.

President John F. Kennedy used expansionary policy to stimulate the economy out of the 1960 recession. He was one of the first advocates of sustaining the policy until the recession was over, regardless of the impact on the debt.

President Franklin D. Roosevelt used expansionary policy to end the Great Depression.

 He then cut back spending on the New Deal in response to pressure to cut the debt. As a result, the Depression reappeared in 1932. FDR returned to expansionary policy to gear up for World War II. That massive spending finally ended the Depression.

For more examples, see

Pros

Expansionary fiscal policy works fast because it can put money into the hands of consumers. It can create jobs and immediately lower unemployment. Most important, it restores the consumer and business confidence. That's critical for them to start spending again. Without that leadership, a recession could turn into a depression. Everyone would just stuff their money under their mattress.

Cons

Tax cuts decrease revenue. That creates a budget deficit that's added to the debt. The tax cuts must be reversed when the economy recovers to pay down the debt. Otherwise, it grows to unsustainable levels. 

The U.S. federal government has no limitation because it prints money. It can pay for the deficit by issuing new Treasury bills, notes, and bonds. As a result, the national debt is now $18 trillion. That's more than the country produces in a year. For more, see Debt to GDP Ratio.

Politicians often use expansionary fiscal policy for reasons other than its real purpose. For example, they might cut taxes to become more popular with voters before an election. That sets up a dangerous situation because they will get voted out of office if the tax cuts are reversed.

Increased spending and lower taxes are often done even when the economy is doing fine. That creates asset bubbles that lead to irrational exuberance and the peak phase of the business cycle. You can guess what follows next, contraction and recession.

Expansionary vs. Contractionary Fiscal Policy

Expansionary policy is used much more frequently than its opposite, contractionary fiscal policy. That's because voters like both tax cuts and more benefits. Therefore, politicians that implement expansionary policy get voted back into office. 

At the state and local level in the United States, communities have put into place balanced budget laws. They cannot spend more than they receive in taxes. That's a good discipline, but it also reduces lawmakers' ability to boost economic growth in a recession.  If they don't have a surplus on hand, they have to cut spending when tax revenues are lower during a recession, which only makes it worse.

Expansionary Fiscal Policy vs. Expansionary Monetary Policy

Expansionary monetary policy is when a nation's central bank increases the money supply. It is very effective in adding more liquidity in a recession. It can also implement contractionary monetary policy, which raises rates and prevents inflation. The long-term impact of inflation can damage the standard of living as much as a recession.

Monetary policy works faster than fiscal policy. The Fed can easily vote to raise or lower rates at its regularly FOMC meeting. It may take about six months for the effect to percolate throughout the economy.

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