Problems, Criticisms, and Complications

Problems, Criticisms, and
Fiscal Policy Evaluations
Why is it so Hard for the Government
to Enact and Apply Fiscal Policy
CrowdingOut Effect
Net Export
Shocks from
1) Timing (Lag-time)
Recognition Lag
• The time between the beginning of recession
or inflation and the awareness that it is
actually occurring.
• This happens because of the difficulty in
predicting the future course of economic
Administrative Lag
• The time between the recognition of the need
for fiscal action and the time action is taken.
• This is a downside of democracy. It might take
months or years for policies to work their way
through the legislative process.
Operational Lag
• It occurs between the time when fiscal action
is taken and when the action takes effect on
output, employment, or the price level.
• Government spending requires long planning
periods and even longer periods of
• While tax rates can be implemented quickly,
people might take time to alter Consumption.
2. Politics
• Politicians want to get re-elected, and often
overlook the best economic course for the
most politically beneficial course.
• The political business cycle emerges, where
politicians may cause inappropriate changes in
AD and cause economic fluctuations,
especially around elections.
3. Offsetting Governments
• At times of recession, provincial governments
might increase taxes or impose new taxes to
offset lower tax revenues resulting from the
reduced personal income and spending of
their citizens.
• The Federal government might be increasing
government spending, but the higher local
taxes restrict AD and GDP from expanding.
4. Crowding-Out Effect
• An expansionary fiscal policy may increase the
interest rate and reduce spending, thereby
weakening or canceling the stimulus of the
expansionary policy.
• Expansionary fiscal policy involves the
government taking loans. Increase in public loans
drives up the demand for loans and increases
interest rates.
• Investment spending and interest rates are
inversely related so some investment will be
"crowded" out.
5. Net-Export Effect
• An expansionary fiscal policy resulting from a
tax cut or an increase in government spending
will shift AD right, this raises prices.
• Foreigners will demand fewer goods because
of the increased price level, which decreases
net exports, and shifts AD left.
• Expansionary fiscal policy intended to increase
C/G/Ig, may be offset by decreased Xn.
6. Shocks from Abroad / Overseas
• Events and policies abroad can shock our
economy and cause unforeseen increases or
decreases in aggregate demand.
• If foreign countries enact spending measures
to stimulate their local consumption, our XN
might rise and vice versa.
• We can be mutually interdependent.
Supply-Side Fiscal Policy:
Business & Personal Tax Cuts
• Tax changes that affect the aggregate supply
curve (AS).
• Tax cuts might shift AS right and negate the
effect of inflation, while increasing economic
growth (GDP)
1. Savings & Investment
2. Work Incentives
3. Risk-Taking
Questions for Exam and Test Review
• Page 275. Questions 7, 8, 9, 11, 12.