14.d Flashcards
(6 cards)
What are the three types of lags in discretionary fiscal policy?
Recognition lag: Time to realize economic problems exist.
Action lag: Time to decide, pass, and implement policy.
Impact lag: Time for policy changes to actually affect the economy.
Why can fiscal policy lags make policy counterproductive?
Because by the time fiscal stimulus is implemented, the economy may already be recovering, potentially leading to overheating and inflation instead of helping a recession.
What are additional macroeconomic issues that hinder fiscal policy effectiveness?
Misreading Economic Statistics
Issue: Fiscal policy relies on accurate economic data to guide decisions. However, measuring “full employment” or determining the exact size of a recession can be difficult.
Impact: If the government misreads economic indicators (e.g., inflation, unemployment, or GDP growth), it may implement the wrong type of fiscal policy (e.g., expansionary policy when the economy is already overheating), leading to poor outcomes like inflation instead of addressing unemployment.
Crowding-Out Effect
Issue: When the government borrows money to finance expansionary fiscal policy (like stimulus spending), it increases demand for funds in the financial markets, which can raise interest rates.
Impact: Higher interest rates make borrowing more expensive for private businesses, leading to less private investment. This reduces the overall effectiveness of the fiscal policy because the goal is to stimulate demand and investment. Some investments become uneconomic when borrowing costs rise.
Supply Shortages
Issue: If the economy is constrained by a lack of available resources (like labor or raw materials), no matter how much the government spends, it won’t increase economic output significantly.
Impact: For instance, if businesses can’t find workers or necessary materials, government spending won’t boost production. Instead, it may only lead to inflation as demand exceeds supply. Expansionary fiscal policy fails because the supply side of the economy is the limiting factor, not the demand side.
Limits to Deficits
Issue: Governments can only borrow so much before they run into problems. If the national debt becomes too high (relative to GDP), investors might demand higher interest rates to lend to the government, or they might stop lending altogether.
Impact: If borrowing costs rise due to concerns about debt sustainability, it can make the fiscal situation worse, especially when interest payments on debt take up an increasing share of government revenue. At some point, trying to fund a deficit through borrowing becomes unsustainable, potentially leading to a debt crisis.
Multiple Targets
Issue: Sometimes, fiscal policy must address multiple macroeconomic goals at once, like high unemployment and high inflation. These goals are often in conflict.
Impact: For example, policies that reduce inflation (like higher taxes or reduced spending) may increase unemployment. Conversely, policies that aim to reduce unemployment (like higher spending or lower taxes) can increase inflation. It’s very challenging to tackle both problems effectively at the same time.
How do economists determine if fiscal policy is expansionary or contractionary? and how should I interpet both
Economists:
Increase in surplus = contractionary.
Increase in deficit = expansionary.
For Exam:
Increase in revenue (e.g., taxes) = contractionary.
Increase in spending (e.g., infrastructure projects) = expansionary.
Why might a rising deficit not necessarily mean expansionary fiscal policy?
Because automatic stabilizers (like lower tax revenues and higher transfer payments during a recession) naturally increase the deficit without any new discretionary action by the government.
What is the structural budget deficit?
The structural (or cyclically adjusted) budget deficit estimates what the deficit would be if the economy were at full employment, isolating the effects of discretionary fiscal policy.
