Final answer:
Expansionary fiscal policy, such as increasing government spending or cutting taxes, is most appropriate when an economy is in recession, which is characterized by low levels of aggregate demand, high unemployment, and output below potential GDP. It aims to increase aggregate demand and stimulate economic growth to overcome recessionary conditions.
Step-by-step explanation:
Expansionary fiscal policy is a macroeconomic tool used by governments to stimulate an economy that is in a state of recession. This type of policy involves increasing government spending or reducing taxes to boost economic activity. When an economy is producing below its potential Gross Domestic Product (GDP), expansionary fiscal policy can help increase the level of aggregate demand, thus facilitating economic growth and reducing unemployment.
During a recession, there is typically a higher than normal level of unemployment and underutilized resources. By implementing expansionary fiscal policy measures, such as government infrastructure projects or tax cuts, consumers have more disposable income, which leads to an increase in consumption and investment. This shift increases aggregate demand, depicted in macroeconomic models as a shift to the right of the aggregate demand curve, and can help an economy move closer to its potential output.
Conversely, contractionary fiscal policy is utilized when an economy is experiencing high inflation or is operating above its potential GDP. In these cases, the goal is to decrease aggregate demand by reducing government spending or increasing taxes, which can help stabilize prices and manage inflation.