Question

Briefly discuss the effects of time lags in relation to fiscal policy, including: a comparison to monetary policy, what the level of fiscal policy will be, and its effect on fiscal policy during recession

Answer 1

There are inside lag and outside lag associated with the fiscal policy. The inside lag reflects the time taken up by the government to recognize the issues faced by the economy and enact a policy, whereas the outside lag is the time taken up by the policy initiatives to show its result. The impact of these time lags is that it not only decreases the effectiveness of the fiscal policy, but also it increase the time length of the positive effects. It leads to the worsening of the economic scenario, if time lags are not controlled. Here, monetary policy should complement fiscal policy to bring positive economic change and stabilize the economy. Here, the key goals and objectives of the fiscal policy and monetary policy should be the same, though the fiscal policy focuses on government spending and taxation, but monetary policy focuses upon money supply, interest rates and inflation using the different instruments.
To counter the time lags and fight recession in the economy, it is the expansionary fiscal policy that is applied by the government. It involves an increased level of government spending and reduction in taxes so that the disposable income level is increased. It will stimulate the demand and the economy moves out of the recession. But, all these efforts can be offset if crowding out effect is not minimized. It means that increased level of government spending should not discourage the private spending. Here, expansionary monetary policy with a lower level of interest rate can help the government to achieve the objective.