Question

Why do you believe fiscal policy is so difficult to make? Is it better to make policies or simply let the economy handle problems? How will you decide this issue?

Answer 1

ans....
Fiscal policy is difficult to frame due to the following reasons:
1. Government expenditure, usually crowds out private investment by pushing up real interest rates in the economy. So an expansionary fiscal policy hurts the productive capability of the economy by contracting private investment.
2. Fiscal policy also becomes a highly politicised issue as it deals with taxation and subsidies. An increase in tax rates might be beneficial for an economy which might be grappling with high fiscal deficits and thus more interest payments but such actions by the government recieve public ire.
3. Moreover, the goverment is mandated with the task of bringing equity in the society through taxes & subsidies. To help the weaker sections of the society, the government might come up with steps which would not lead to an optimal outcome. For instance, protecting domestic manufacturers from foreign imports using tarriffs.
It is better to frame policies as in many cases the economy might not be able to recover from a market disruption within a reasonable time frame. For instance, during the Great Recession, the US government built several of the massive projects that we see today. This was done because investment was not picking up after the recession, so to create more jobs the government started spending. In other cases, the government gives a taxcut to households so that consumption picks up again.
We can say that fiscal policy becomes more like a catalyst in the adjustment process for the economy.
We can decide the issue by gauging two metrics: state of the economy in the business cycle and the fiscal space with the government. Some normative arguments related to social welfare like income and wealth ineqaulity also needs to be taken into account.
If the economy is growing below its potential then an expansionary fiscal policy should be followed. More government expenditure, reduced tax rates are the solution. Quality of growth will depend on whether the government is spending on investment or consumption.
On the other hand, if the economy is overheating then austerity measures should be taken by the government.
At the same time, the government should see that it is not running high deficits. It should check primary(fisca deficit-terest payments) and revenue deficit.
Usually a countercycylical fiscal policy along with market forces will bring the economy back to its normal state.