Under which scenario would expansionary fiscal policy work BEST?
A) when two real shocks have occurred
B) when the economy is at equilibrium in the long run
C) when the economy has had a large negative supply shock
D) when AD is low compared with the long-run equilibrium position of the economy

Question

Quizplus · Accepted Answer

Expansionary fiscal policy is most effective when there is low aggregate demand compared with the long-run equilibrium position of the economy. This is because in this scenario, there is room for the government to increase spending and boost demand without causing inflationary pressures. If there has been a large negative supply shock (Choice C), this may lead to inflation even with expansionary fiscal policy, while two real shocks (Choice A) may require addressing the underlying structural issues rather than a short-term stimulus. When the economy is at equilibrium in the long run (Choice B), expansionary fiscal policy may not be necessary as the economy is already operating at its full potential.

Under Which Scenario Would Expansionary Fiscal Policy Work BEST