There are three types of fiscal policy: neutral policy, expansionary policy,and contractionary policy. In expansionary fiscal policy, the government spends more money than it collects through taxes. This policy works best in times of economic booms.

Introduction. Expansionary fiscal policy is when the government increases the money supply in the economy using budgetary instruments to either raise spending or cut taxes—both having more money to invest for customers and companies.

Expansionary fiscal policy will lead to higher output today, but will lower the natural rate of output below what it would have been in the future. Similarly, contractionary fiscal policy, though dampening the output level in the short run, will lead to higher output in the future.

A potential problem of expansionary fiscal policy is that it will lead to an increase in the size of a government’s budget deficit. Higher borrowing could: Financial crowding out. Larger deficits could cause markets to fear debt default and push up interest rates on government debt.

Large scale underemployment, lack of coordination from the public, tax evasion, low tax base are the other limitations of fiscal policy.

Supply-siders don’t worry much about budget deficits. They believe that tax cuts will stimulate the economy and bring in additional tax revenues so that that tax cuts lead to more revenues and thus lower budget deficits.

Fiscal policy is the use of government spending and taxation to influence the economy. Governments typically use fiscal policy to promote strong and sustainable growth and reduce poverty.