Question

Which of the following statements is true about an expansionary fiscal policy?

A It decreases demand for loanable funds.
B it decreases the equilibrium price level.
C It decreases the equilibrium real interest rate.
D it increases aggregate demand.
E It increases the money supply

Answer 1

Expansionary fiscal policy increases aggregate demand by stimulating spending through tax cuts or increased government spending, even though it may eventually lead to higher interest rates and some crowding out effects. Hence, the correct answer is option (D).

Step-by-step explanation:

Of the statements provided regarding an expansionary fiscal policy, the one that is true is that it increases aggregate demand. Expansionary fiscal policy involves government actions such as tax cuts or spending increases with the intention to stimulate the economy by increasing consumer and business spending.

While this type of policy can lead to an increase in aggregate demand, it might also cause higher interest rates which can result in some crowding out, reducing the policy's effectiveness. However, the initial impact of such a policy is still an increase in aggregate demand.