Which statement best describes the difference between expansionary and contractionary fiscal policy?

• A. Expansionary fiscal policy is conducted by the central bank through lowering interest rates, while contractionary fiscal policy is conducted by the central bank through raising interest rates.
• B. Expansionary fiscal policy decreases aggregate demand by cutting government spending and/or raising taxes, while contractionary fiscal policy increases aggregate demand by raising government spending and/or cutting taxes.
• C. Expansionary fiscal policy always reduces the budget deficit, while contractionary fiscal policy always increases the budget deficit.
• D. Expansionary fiscal policy increases aggregate demand by raising government spending and/or cutting taxes, while contractionary fiscal policy decreases aggregate demand by cutting government spending and/or raising taxes.

Answer: (D)

Verified step by step guidance

1. Step 1: Understand the definition of fiscal policy. Fiscal policy involves government decisions on taxation and government spending to influence the economy.
2. Step 2: Recognize that expansionary fiscal policy aims to stimulate economic growth by increasing aggregate demand. This is typically done by raising government spending and/or cutting taxes.
3. Step 3: Understand that contractionary fiscal policy aims to slow down economic growth or reduce inflation by decreasing aggregate demand. This is usually achieved by cutting government spending and/or raising taxes.
4. Step 4: Differentiate fiscal policy from monetary policy. Fiscal policy is conducted by the government through spending and taxes, whereas monetary policy is conducted by the central bank through interest rates.
5. Step 5: Summarize the key difference: Expansionary fiscal policy increases aggregate demand by increasing government spending or cutting taxes, while contractionary fiscal policy decreases aggregate demand by reducing government spending or increasing taxes.