Which action typically occurs during contractionary fiscal policy?

Which action typically occurs during contractionary fiscal policy?

• A. Increasing government spending
• B. Introducing tax cuts
• C. Raising taxes
• D. Increasing transfer payments

Answer: (C)

During contractionary fiscal policy, the primary aim is to reduce inflationary pressures in the economy. This is achieved by decreasing aggregate demand, and one common method to do this is by raising taxes. Higher taxes reduce the disposable income of consumers and businesses, leading to decreased spending on goods and services. This reduction in consumption helps to cool down an overheating economy, where demand may be exceeding supply, resulting in inflation. In contrast, options such as increasing government spending, introducing tax cuts, or increasing transfer payments would stimulate the economy by increasing overall demand. These actions are characteristics of expansionary fiscal policy, which aims to boost economic activity, especially during times of recession or economic downturn. Therefore, raising taxes aligns with the goals of contractionary fiscal policy by directly influencing disposable income and thereby consumer spending.

During contractionary fiscal policy, the primary aim is to reduce inflationary pressures in the economy. This is achieved by decreasing aggregate demand, and one common method to do this is by raising taxes. Higher taxes reduce the disposable income of consumers and businesses, leading to decreased spending on goods and services. This reduction in consumption helps to cool down an overheating economy, where demand may be exceeding supply, resulting in inflation.

In contrast, options such as increasing government spending, introducing tax cuts, or increasing transfer payments would stimulate the economy by increasing overall demand. These actions are characteristics of expansionary fiscal policy, which aims to boost economic activity, especially during times of recession or economic downturn. Therefore, raising taxes aligns with the goals of contractionary fiscal policy by directly influencing disposable income and thereby consumer spending.