Changes in taxation or expenditure in order to reduce demand in an economy
Below is a graph to breakdown the economic effects of a government running a contractionary fiscal policy in an AD/AS framework. This can be achieved through raising taxes, decreasing government expenditure or possibly both from the classical viewpoint. The immediate impact is that the AD curve shifts inwards creating a decelerating inflation rate.
It it important to note that the impact on economic growth depends on which sectors of the economy the fiscal policy was targeted. As a cut in spending towards productive sectors of the economy could cause the LRAS curve to inwardly shift. This is a key evaluation point to mention when dealing with fiscal policy.
