Definition
- Contractionary fiscal policy
- Contractionary fiscal policy decreases aggregate demand through government spending cuts or tax increases, and suits an overheating economy with output above potential GDP.
Example
Can you think of an example of contractionary fiscal policy?
Two years later inflation is well above target, so the next Budget raises income tax by a penny in the pound and trims departmental budgets. Households spend less and government purchases fall.
Test yourself
Can you name the two directions fiscal policy can take?