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Explain how a government can use fiscal policy to help an economy recover from a recession.

Fiscal policy is the use of government spending and taxation to control the levels of aggregate demand and aggregate supply in an economy.When an economy is recovering from a recession, the real rate of GDP growth is likely to be lower than the long run trend rate of GDP growth. This suggests the economy is suffering from some level of demand-deficiency in the economy. To combat this, the government can use expansionary fiscal policy, on the demand side. An example of this is lowering direct taxes such as income taxes. This effectively increases consumers’ incomes. As consumers have higher incomes, their consumption will likely increase, since they want to maximise their utility. Since AD = C + I + G + (X-M), AD is likely to increase as a result of this, and so too will national output, GDP, thus helping to aid the recovery from recession.



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