Question

Discuss the various fiscal policy levers used by politicians and bureaucrats to guide the economy in the direction they deem most beneficial. Detail the effects of discretionary fiscal policies, the impact of crowding out, time lags, and automatic stabilizers. How do these policy actions change your behavior regarding spending and saving?

Answer 1

Politicians and bureaucrats often guide the economy in the desirable direction by adjusting or changing the taxation policies or the government spending. These can be initiated using various fiscal policy actions such as a expansionary fiscal policy can be used to increase government spending or to decrease taxation, sometimes both, simultaneously. Expansionary fiscal policy will drag the economy out of recession by incresing the aggregate demand which can onset an increase in production and employment.

Under discretionary fiscal policies, the government can either choose to apply expansionary or contractionary policies. When the economy is suffering a downfall, the government can choose to expand its fiscal policy by increasing its spending and reducing the taxes. This will boost the economy by increasing efficiency and production which will in turn increase the aggregate demand and employment.
Crowding out takes place when interest rates increase as result of increased government borrowings and pushing the private sector out of the market by making them worse off as investment opportunity has become expensive.
Time lag occur when the government cannot figure out the exact cause of the problem or the time take by the government to put the policies into action known as recognition lag and implementation lag respectively. One major effect of this lag can be the fact that new problems may emerge in the meantime.
When an economy overheats, that is, when the production of goods can not match up with the aggregate demand of the economy, automatic stabilizers which is a type of fiscal policy neutralizes the fluctuations of the economy without any intervention from the government.
When the government expands its fiscal policy, it will increase its spendings and this will led to crowding out effect by increasing the interest rate and therefore, my behaviour as a consumer, I will decrease my spendings and increase my savings for future purposes in the anticipation of even higher interest rates in the economy. In case of expansionary fiscal policy, however, my disposable income will increase as a result of increased production and employment in the economy, therefore, I will spend more on consumption goods and save less.