How can expansionary fiscal policies support an economy in closing a deflationary/recessionary gap?

Expansionary fiscal policies expand aggregate demand (AD) by increasing government spending and/or decreasing income and corporate taxation. As a result, a recessionary (a.k.a. deflationary) gap, which is caused by insufficient AD can be closed. AD1 intersects the neo-classical SRAS curve 'a' and Keynsian AS curve 'b' at a level of real GDP (Y1). This is below the full employment level of output (YFE). Expansionary fiscal policies shift AD rightwards (AD1 to AD2), closing the gap. This causes more inflation (PL1 to PL2) and less growth (Y1 to Y2) in the neo-classical model compared to the Keynsian model.

Answered by Sai Bhargav K. Economics tutor

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