During a recession, an appropriate expansionary fiscal policy would be to:

Question

Accepted Answer

Decrease taxes and increase government spending. Expansionary fiscal policy aims to increase aggregate demand and stimulate economic growth during a recession. This involves decreasing taxes (which increases disposable income and consumer spending) and/or increasing government spending (which directly adds to aggregate demand). Both actions shift the AD curve to the right, increasing real GDP and reducing unemployment.

Increasing taxes and decreasing spending is contractionary fiscal policy  -  the opposite of what is needed during a recession. "Increase the required reserve ratio", "Decrease taxes and increase government spending", "Sell government bonds on the open market", and "Sell government bonds on the open market" describe monetary policy tools, not fiscal policy. Increasing the reserve ratio or selling government bonds would reduce the money supply and raise interest rates, which is contractionary monetary policy conducted by the Federal Reserve, not fiscal action by Congress.

The distinction between fiscal policy (government spending and taxation, controlled by Congress and the President) and monetary policy (money supply and interest rates, controlled by the Federal Reserve) is critical on the CLEP exam. Expansionary fiscal policy during recessions can be effective at boosting output, but it also increases the budget deficit and may lead to crowding out  -  when government borrowing raises interest rates and displaces private investment. Understanding these tradeoffs is essential for policy analysis questions on the exam.

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