Question

You have now read and learned about fiscal policy and the impact that it may have on our debt. With everything you have learned thus far, do you believe that fiscal policy is a good thing for the economy? In what ways may it be bad and/or good for the economy? If you could choose between Keynsian Fiscal Policy or letting the economy self-correct what would you choose?

Answer 1

Fiscal policy has both advantages and disadvantages

Advantages

Fiscal policy refers to the taxing and spending policies of the government. Objectives of fiscal policy can include

• Influencing the level of economic activity
• Redistributing wealth or income.
• Allocating resources among industries

Revenue and Spending Tools

Fiscal policy tools include spending tools and revenue tools. Spending tools include transfer payments, current spending (goods and services used by government), and capital spending (investment projects funded by government). Revenue tools include direct and indirect taxation.

An advantage of fiscal policy is that indirect taxes can be used to quickly implement social policies and can also be used to quickly raise revenues at a low cost.

Disadvantages

Time lags.

There is a lag until the problem is recognised by the government authorities and economists. Theappropriate policy is decided by the government. The policy takes effect in the economy.

Political constraintts

Fiscal policy may face pressures such as merit goods cannot easily be cut. Tax increases may also be unpopular and may be avoided even if necessary. Tax decreases may be inappropriately enacted because they are politically popular.

Crowding out

If the government uses expansionary fiscal policy increasing spending without an increase in revenues, it is forced to borrow. This is called deficit spending. This will lead to an increase in interest rate, which will lead to a decrease in investment by private firms, or a "crowding out" of private investment.This means the governments increase in G has resulted in lower I.

Inability to deal with supply side causes of instability

If instability is cause by supply side factors, leading to stagflation, where there is falling real GDP and inflation simultaneously, fiscal policy is unable to deal with it.

Self Correction vs Keynesian Fiscal Policy.

Classical economists believe the market to be self-correcting and focus on long-run growth aimed at expanding the LRAS. Keynesian economists believe that market corrections can take a long time due to sticky wages, and focus on policy aimed at AD. Economist generally agree that the economy can be self-correcting in the long run, but disagree about the relative importance of the short run and long run.

Because fiscal policy affects the quantity of money that the government borrows in financial capital markets, it not only affects aggregate demand—it can also affect interest rates. If an expansionary fiscal policy also causes higher interest rates, then firms and households are discouraged from borrowing and spending, reducing aggregate demand in a situation called crowding out. Given the uncertainties over interest rate effects, time lags (implementation lag, legislative lag, and recognition lag), temporary and permanent policies, and unpredictable political behavior, knowledgeable policymakers have concluded that discretionary fiscal policy is a blunt instrument and better used only in extreme situations.

Automatic stabilizers are economic policies and programs designed to offset fluctuations in a nation's economic activity without intervention by the government or policymakers on an individual basis. Automatic stabilizers are so called because they act to stabilize economic cycles and are automatically triggered without explicit government action. Corporate and personal taxes and transfer systems (unemployment insurance and welfare).When an economy Is in recession automatic stabilizers may result in higher budget deficits. Higher budget deficits can be due to the higher level of benefit payouts being used to support individuals or businesses in the economy, as well as the fall in the total amount of revenue being received.

To conclude it is better to use a combination of both Fiscal policy and Self Correction measures to correct the economy.