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Contractionary Fiscal Policy Fiscal policy Contractionary fiscal policy (see fiscal policy) is the deliberate change in government spending or taxes in order to slow the economy (to prevent inflation). It may fight inflation, decrease trade deficit, and make interest rates fall to stimulate the economy in the long run. However, the government prefers to use contractionary fiscal policy as few times as possible, and relies much more heavily on contractionary monetary policy to combat inflation. The reason for this is the following: monetary policy is run by the Federal Reserve Board, which does not have to deal with politics. The U.S. Congress and President, however, are a different story. They are concerned with short-run economic effects (the President does not care if the economy will multiply a hundred times in 10 years, s/he wants people to vote for him/her in four years). In the short run, contractionary fiscal policy may increase unemployment, risk recession, slow output growth, and cause various political problems. Also, fiscal policy (whether expansionary or contractionary) assumes things that are not necessarily true in real life: like that the government can change taxes almost instantaneously or that the government knows the exact extent of (in the case of contractionary fiscal policy) inflation. To quote the textbook Economics, by Professor Colander, "fiscal policy is a sledge hammer, not an instrument for fine tuning. When the economy goes into a depression, the appropriate fiscal policy is clear. Similarly when the economy has hyperinflation, the apporpriate policy is clear..." However, in between, a good mix of contractionary monetary policy and contractionary fiscal policy can keep inflation in check.
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