Expansionary fiscal policy will most likely result in an increase in aggregate demand, real GDP, and employment, but with a higher budget deficit and some upward pressure on the price level (inflation), especially if the economy is near full capacity.

What expansionary fiscal policy is

  • Expansionary fiscal policy means the government increases spending, cuts taxes, or both in order to stimulate economic activity.
  • These actions raise households’ disposable income and firms’ after‑tax profits, encouraging higher consumption and investment.

Most likely macroeconomic effects

  • Higher government spending and/or lower taxes shift aggregate demand to the right, raising real output (GDP) and reducing cyclical unemployment, particularly in a recession.
  • As demand rises, the general price level tends to increase, so inflationary pressure is a common side effect if there is limited spare capacity.

Effects on budget and interest rates

  • Because spending rises and/or tax revenue falls, the government budget deficit typically increases and public debt grows.
  • Financing higher deficits can put upward pressure on interest rates and partially “crowd out” private investment if the economy is already strong and credit markets are tight.

When outcomes differ

  • In a deep recession with high unemployment and plenty of unused capacity, expansionary fiscal policy is more likely to raise output and jobs with relatively modest inflation.
  • In an economy near full employment, the same policy is more likely to show up mainly as higher inflation and interest rates, with a smaller gain in real GDP.