Question

Discuss the issue of lags in fiscal policy, and the relative advantages and disadvantages of automatic and discretionary policies. Further, explain why having a balanced budget might not be desirable (hint, think about how it might limit automatic stabilizers).

Answer 1

Discretionary fiscal policies are subject to the same monetary policy lags that we discussed. It takes the policymakers some time to realize that there is a recessionary or inflationary gap the lag in recognition. Recognition lags stem largely from the difficulty of the timely and accurate collection of economic data. Fiscal policy changes are likely to involve a particularly long lag in implementation. Some economists have concluded that this stabilization tool is ineffective because of the long implementation lag for discretionary fiscal policy. Thankfully, automatic stabilisers automatically respond to economic changes.

The lag in implementation stems in part from the very existence of bureaucracy itself. The CBO forecasts that, over the next two years, only a fraction of the funding for the stimulus package passed over 2009 will be spent is an indication of the implementation lag. Government spending needs the approval of the expenditure by bureaucracy.

Fiscal spending policies stabilise the economy. They come into effect when the government passes new laws which increase the amount of tax or spending. These measures are generally taken during either recessions or booms. Like discretionary fiscal policies, output and demand are balanced by automatic stabilisers. The difference is that government spending and tax rate increases take place without any concerted legislative intervention. In other words, they are not to be voted on by Congress. These initiatives may include (but are not limited to) opportunities for jobs, tax cuts, progressive taxation, farmers' subsidies and compensation for unemployment.

A disadvantage of the automatic stabilization strategy is that if inflation is triggered by factors other than those that influence aggregate demand, this does not work. In comparison, discretionary fiscal policies may fix economic problems not related to aggregate demand.

Although Congress will decide the budget for each coming year more or less, no one knows in advance precisely what the incoming cash flows of the federal government will be those primarily depend on potential economic activity. Therefore, an amendment will possibly have to rely on expenditure estimates, rather than on hard figures. But relying on projections could make tinkering impossible with those projections. In addition, in the case of national emergencies, such as war and financial crises, an amendment will possibly need to authorize Congress to suspend the balanced budget requirement. It is likely that a future Congress would use the national emergency clause to avoid the requirement of a balanced budget.