Explain the circumstances under which expansionary fiscal policy will result in growth, without inflation.



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Posted on (Answer #1)

In order for an expansionary fiscal policy to lead to economic growth with absolutely no inflation, the macroeconomic equilibrium must be at a point on the aggregate supply (AS) curve where that curve is flat .  This will typically be true when the economy is in a severe slump.

An expansionary fiscal policy will result in an increase in aggregate demand (AD).  This will be represented on a graph by a movement of the AD curve to the right.  The impact on GDP and on the price level will therefore depend on the shape of the AS curve at the point where it intersects with the AD curve.

Look at the AS curve in this link.  If expansionary fiscal policy is undertaken when the AD curve intersects any point on this AS curve, some degree of inflation will result.  This is because the AS curve slopes upward through its whole range. 

Now look at this link.  The AS curve here is flat for part of its range.  If the AD curve intersects it far to the left, expansionary fiscal policy can move AD to the right without any increase in the price level.  This is growth without inflation.  It happens when the economy has been in a serious slump and there are lots of resources (labor, machinery, etc) going unused.


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