Contractionary Fiscal Policy Flashcards, test questions and answers

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What is Contractionary Fiscal Policy?

Contractionary fiscal policy is an economic method used by governments to reduce government spending and increase taxes in order to slow down the rate of growth in an economy. This type of policy is typically used when inflation is rising faster than expected, or when the government needs to reduce its debt levels.The principle behind contractionary fiscal policy is that reducing spending and increasing taxes will slow down the rate of economic growth, thereby reducing inflation. Government spending cuts are meant to decrease demand for goods and services while increased taxes take money out of consumer’s pockets, further reducing consumer spending. This reduction in overall demand can help cool off a hot economy and reduce inflationary pressures. In addition, if successful, this type of policy can also help bring down public debt levels as fewer resources need to be devoted towards servicing public debt obligations. However, contractionary fiscal policies also have their drawbacks. By cutting government spending, it means that there will be fewer funds available for important social programs or infrastructure projects which could hurt the economy and lead to slower long-term economic growth. Additionally, increased taxes can place a burden on consumers who may not have disposable income available after paying their tax bills; this could lead them to cut back on their own spending as well as leading businesses to experience weaker sales which may cause them to layoff workers or close completely. In conclusion, contractionary fiscal policies are a useful tool for governments looking to reduce public debt levels and curb inflation; however they must be carefully implemented so as not to harm the underlying health of an economy or strain those already struggling financially due to high tax rates.