Can contractionary fiscal policy--taxing more than spending--ever have a place during times of recession?

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justaguide's profile pic

justaguide | College Teacher | (Level 2) Distinguished Educator

Posted on

One view holds that a contractionary policy cannot work during a recession. Reducing money that people can spend is not going to help the producers as it would reduce demand. And the only way to get out of a recession is to increase demand to provide an impetus to producers, which increases employment and wages.

Taxing people and reducing spending may make people feel that the government is trying to decrease deficit, but every economic policy that is adopted by the government has an appropriate time. During a recession people are least bothered about the deficit resulting from increased spending by the government and a reduction in the taxes collected. There are things which have to be dealt with at a higher priority.

A contractionary policy is adopted to curtail the formation of bubbles, reduce inflation and can be something a government can adopt once the economy is on track and can move forward on its own.

pohnpei397's profile pic

pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted on

Macroeconomics is not an exact science so there is no way to be 100% sure.  However, it is clear, for example, that Republicans in the United States (as well as the British government and others) feel that contractionary fiscal policy does have a place in bad economic times.

The idea behind this would be that lower spending would reduce the government's deficit and thereby increase consumer confidence. Some economists argue that, in countries where the deficit is already quite high, the deficit makes people worry that the country is fundamentally unstable.  It may also make foreign investors feel this way.  This is a real problem.  If consumers do not want to buy, aggregate demand goes down.  If foreign investors do not want to invest, interest rates go up and there is less money coming into the economy.  Both of these could make a recession worse.

The idea is, then, that contractionary fiscal policy would demonstrate that the government is serious about fixing the country's problems.  This would encourage consumer spending and foreign investment.  Both would help improve the country's economy.

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